By Simon Lester in Currency Disputes — 16 Oct 2009

Fred Bergsten on Currency Undervaluation

From an article entitled "The Dollar and the Deficits: How Washington Can Prevent the Next Crisis":

A central goal of US foreign economic policy must be to prevent and counter deliberate currency undervaluations by other major countries, which keep the dollar overvalued and harm US competitiveness. China has been the glaring culprit in recent years: it has run current account surpluses exceeding ten percent of its GDP and has intervened massively in the currency markets to keep the value of the renminbi from rising. China's currency has risen a good deal anyway, and its trade surplus is now coming down, but its external imbalance is still very large, and the renminbi remains priced at 20-40 percent below equilibrium. Switzerland, a small country that is an important player in world trade, is another case in point: its aggressive, although admirably transparent, intervention in the currency markets has served to weaken the exchange rate of the Swiss franc despite the country's huge current account surpluses. Over the next few years, as more countries seek to export their way out of the current crisis and build larger war chests of foreign exchange to self-insure against future exigencies, there could be more, and more serious, examples of such neomercantilism. Such a development would greatly complicate US efforts to avoid renewed increases in its own external deficits.

Any serious US effort to curb the United States' international imbalance will thus have to counter the beggar-thy-neighbor policies of other countries. The most desirable route would be multilateral surveillance and "name and shame" efforts by the IMF to identify currency misalignments and induce the perpetrators to make prompt adjustments. However, the IMF has no effective leverage over creditor countries; in fact, it has recently abandoned any serious effort to bring China's and other countries' currency imbalances under control. An alternative would be to enforce the provisions of the World Trade Organization that prohibit competitive currency action and authorize trade sanctions against violators.

The Bretton Woods system was erected at the end of World War II to avoid a repetition of the trade protectionism and competitive currency devaluations of the 1930s, which intensified the Great Depression and sowed the seeds of war. The system is now undergoing its first real stress test, and so far, it has not demonstrated its ability to fulfill its fundamental mission. Without effective multilateral action—or, in fact, to prod such action—the United States might have to take unilateral trade steps against violating countries, much as it did in 1971, when Nixon imposed an import surcharge, and, to a lesser extent, in the mid-1990s, when Bill Clinton applied trade pressure to get Japan to allow the yen to appreciate.