Contents

Executive summary

U.S. trade and investment agreements have almost always resulted in growing trade deficits and job losses. Under the 1993 North American Free Trade Agreement, growing trade deficits with Mexico cost 682,900 U.S. jobs as of 2010, and U.S.-Mexico trade deficits and job displacement have increased since then. President Obama promised that the U.S.-Korea Free Trade Agreement would increase U.S. goods exports by between $10 billion and $11 billion, supporting 70,000 American jobs from increased exports alone. However, in the first two years after that deal went into effect, U.S. exports actually declined, and growing trade deficits with South Korea cost nearly 60,000 U.S. jobs. The U.S. trade deficit with South Korea continues to rise.

This is important to keep in mind as secret negotiations for the Trans-Pacific Partnership (TPP) continue, most recently in Washington and New York. The United States has a large and growing trade deficit with Japan and the 10 other countries in the proposed TPP. This deficit has increased from $110.3 billion in 1997 to an estimated $261.7 billion in 2014.

Additionally, several members of the proposed TPP deal are well known currency manipulators, including Malaysia, Singapore, and Japan. In fact, Japan is the world’s second largest currency manipulator, behind China. The United States should not sign a trade and investment deal with these countries that does not include strong prohibitions on currency manipulation. Yet U.S. Trade Representative Michael Froman has testified that currency manipulation has not been discussed in the TPP negotiations (McCormack 2014).

As one of the world’s largest currency manipulators, Japan is responsible for a substantial share of the bloated U.S. global trade deficit. Eliminating currency manipulation by about 20 developing and developed countries (including Japan) could reduce the U.S. global trade deficit by between $200 billion and $500 billion each year, which could increase overall U.S. GDP by between $288 billion and $720 billion and create between 2.3 million and 5.8 million U.S. jobs. This report evaluates the impacts of Japan’s currency manipulation, specifically as manifested in the U.S. trade deficit with Japan, on the U.S. economy and jobs. It finds that currency manipulation by Japan has resulted in a large, persistent U.S. trade deficit with Japan that has displaced hundreds of thousands of U.S. jobs:

• The U.S.-Japan goods trade deficit reached $78.3 billion in 2013, reducing U.S. GDP by $125.3 billion or nearly 0.75 percent of actual GDP in that year. Japan’s currency manipulation was the most important cause of this deficit, which displaced 896,600 U.S. jobs in 2013, with job losses in every state and nearly all U.S. congressional districts.
• The 896,600 jobs eliminated by the U.S. goods trade deficit with Japan included 148,400 direct jobs in commodity and manufacturing industries that competed with unfairly traded imports and exports from Japan. The currency-manipulation-fueled trade deficit was also responsible for the loss of 412,000 indirect jobs in supplier industries, and an additional 336,200 “respending” jobs—jobs that would have been supported by the wages of workers displaced by trade with Japan.
• The nearly 900,000 direct, indirect, and respending jobs displaced by the U.S.-Japan trade deficit in 2013 affected multiple sectors and industries. Job losses include 466,000 manufacturing jobs (52 percent of the jobs lost due to the U.S.-Japan trade deficit). Within manufacturing, by far the largest losses occurred in motor vehicles and parts, which lost 118,800 jobs (13.3 percent of total jobs lost). Other manufacturing industries with large losses include machinery (96,600 jobs), fabricated metal products (80,800 jobs), and computer and electronic parts (66,100 jobs). The U.S.-Japan trade deficit was also responsible for significant job losses outside of manufacturing in administrative and support industries (61,800 jobs); health care and social assistance (60,500 jobs); retail trade (51,800); professional, scientific, and technical services (50,000 jobs), and accommodation and food services (48,500 jobs). Net trade with Japan also created a total of 63,600 jobs in U.S. agricultural industries.
• The U.S.-Japan trade deficit also reduced tax revenues and increased safety net expenditures in 2013, increasing the federal budget deficit by $46.4 billion, 7.4 percent of the federal budget deficit in that year. If the U.S. trade deficit with Japan were to persist at the 2013 level for the next 10 years, the loss of jobs and wages would add $460 billion to the total federal deficit over the next decade. The U.S.-Japan trade deficit also reduced net state and local resources by $17.5 billion in 2013, alone.
• Each of the 50 states and the District of Columbia lost jobs due to the U.S. trade deficit with Japan in 2013. Job losses were greatest in Michigan, where they constituted 1.34 percent of total state employment.
• Eight of the 10 states with the highest job losses (as a share of total employment) are in the Midwest or the East South Central census regions, all states where manufacturing predominates: Michigan (56,200 jobs), Indiana (33,700 jobs), Ohio (50,900 jobs), Kentucky (16,400 jobs), Wisconsin (24,300 jobs), Tennessee (23,200 jobs), Alabama (16,000 jobs) and Illinois (45,500 jobs). Rounding out the top 10 states losing the largest shares of jobs  were South Carolina (16,800 jobs) in the South Atlantic region, and New Hampshire (5,300 jobs) in New England.
• The U.S. trade deficit with Japan resulted in net job losses in all but three U.S. Congressional Districts, and has displaced up to 6,000 jobs in a single U.S. congressional district. In the 20 congressional districts with the largest shares of jobs lost, losses ranged from 3,100 to 6,000 jobs. The 10 th Congressional District in Michigan was the hardest hit district in the country, ranked in terms of jobs displaced as a share of total district employment, losing 5,500 jobs (1.78 percent of total employment). Among these top 20 U.S. congressional districts, job losses as a share of district employment ranged from 1.17 percent to 1.78 percent. Of the states with top-20 job-losing districts, the hardest hit state was Michigan (with 10 districts in the top 20, followed by Indiana (four districts); Ohio and South Carolina (two districts each); and California and Wisconsin (one each).

Currency manipulation is the most important cause of the large and growing U.S. trade deficit with Japan. In the past two years, Japan has driven down the value of the yen primarily through large purchases of foreign assets, and also and by announcing its intention to reduce the yen’s value.

Purchases and holdings of foreign exchange reserves by the Bank of Japan and of other foreign assets by Japan’s Government Pension Investment Fund (GPIF) are an indispensable element of Japan’s currency policy. Without its massive government holdings of foreign assets, and its continuing and periodic massive purchases of new foreign assets, the government of Japan would have been unable to prevent the yen from adjusting to levels consistent with large trade and current account surpluses.

It is important to distinguish the effects of quantitative easing (defined as central bank purchases of assets denominated in its own currency) from currency intervention (defined as government purchases of assets denominated in foreign currencies). All countries should be free to engage in quantitative easing and other elements of domestic monetary policy, subject only to their own domestic policy goals and constraints (such as excessive inflationary pressure, as perceived by domestic authorities, as well as domestic employment and wage targets). Domestic monetary policies should not be labeled as part of currency manipulation, and such policies should not be constrained by international agreements. Prudential measures are appropriate to deal with short-term economic problems.

In short, all countries should be free to print money to purchase their own domestic assets. On the other hand, countries should be strongly discouraged from purchasing and holding assets denominated in foreign currencies, which is the central, defining tool of currency manipulation.

In this context the United States should insist that currency manipulation be directly addressed in the proposed Trans-Pacific Partnership. Members of the TPP should also agree to rebalance trade and currency markets, including through divestiture of excess foreign assets in government portfolios, before any trade and investment agreement takes effect. They should also forswear the use of currency manipulation in the future, and submit to strong, binding currency disciplines in the event these commitments are violated.

Background: Currency manipulation, trade, and job loss

Growing trade deficits have cost U.S. workers millions of jobs over the past two decades. Most of the lost jobs were good jobs in manufacturing industries. Under the 1993 North American Free Trade Agreement (NAFTA), growing trade deficits with Mexico cost 682,900 U.S. jobs through 2010, and U.S.-Mexico trade deficits and job displacement have increased since then (Scott 2011, 2014c). President Obama promised that the U.S.-Korea Free Trade Agreement would increase U.S. goods exports by between $10 billion and $11 billion, supporting 70,000 American jobs from increased exports alone (White House 2010). However, in the first two years after that deal went into effect, U.S. exports actually declined, and growing trade deficits with Korea cost nearly 60,000 U.S. jobs (Scott 2014d).

The job losses stemming from past trade deals must inform continuing negotiations for the Trans-Pacific Partnership, which have proceeded in secret, most recently in Washington and New York (Arirang News 2014, and Brunnstrom 2015). The United States has a large and growing trade deficit with Japan and the 10 other countries in the proposed TPP; this deficit with the TPP countries increased from $110.3 billion in 1997 to an estimated $261.7 billion in 2014 (Scott 2014a).

Currency manipulation by more than 20 countries is the most important reason why U.S. trade deficits have not decisively reversed (Bergsten and Gagnon 2012). Currency manipulation by other counties lowers the value of the countries’ currencies relative to the U.S. dollar, which acts as a subsidy to those countries’ exports, and a tax on U.S. exports to every country where the U.S. competes with the exports of currency manipulators. After China, Japan is the world’s largest currency manipulator and thus responsible for a substantial share of the bloated U.S. global trade deficit. 1 Laffer (2014, 2) also concludes that currency manipulation has cost millions of U.S. jobs, and that by falling back into old patterns of currency manipulation, Japan is “foisting the burden of its flawed policies onto its trading partners.”

Elimination of currency manipulation by about 20 developed and developing countries could reduce the United States’ global trade deficit by between $200 billion and $500 billion (Bergsten and Gagnon 2012). This reduction could increase U.S. GDP by between $288 billion and $720 billion, and create between 2.3 million and 5.8 million U.S. jobs (Scott 2014b).

The biggest tool of currency manipulation is the purchase of assets denominated in the currencies of other countries, which is known as currency intervention. Purchases of foreign assets by central banks and other government agencies in Japan, China, and other countries directly increase the demand for foreign currencies, especially the U.S. dollar. This increases the value of the dollar (the exchange rate), and drives down the value of the currency of the country purchasing foreign assets. Foreign assets include Treasury bills, other government assets (which are held as foreign exchange reserves by central banks), and foreign stocks and bonds (purchased by other government agencies, such as the Japanese pension fund, discussed below).

The importance of exchange-rate manipulation in driving global trade imbalances is clear. There is a near perfect correlation between official purchases of foreign exchange reserves and other foreign assets and the global current account surpluses of currency manipulators. Recent research has shown that causation runs from currency manipulation to trade surpluses among the manipulators, and not the other way around. Gagnon (2013) estimated that a “country’s current account balance increases between 60 and 100 cents for each dollar spent on intervention.” Importantly, his data include asset purchases by government-owned “sovereign wealth funds” (also known as SWFs) which now control over $7.0 trillion dollars in assets (SWFI 2015). For example, in November 2014, Japan’s gigantic Government Pension Investment Fund, whose assets totaled over $1.2 trillion in 2013, announced that it intended to raise the target share of its assets held in foreign stocks and bonds from 23 percent in 2013 to 40 percent (approximately $480 billion) in the near future (Warnock and Narioka 2014). This will have a significant impact on Japan’s expected future trade surplus because it will directly suppress the value of the yen, in ways that are described below.

Currency manipulation, trade, and Japan

Japan has a long history of currency manipulation. Between 2000 and November 2014 its holdings of foreign exchange reserves alone nearly quadrupled, rising from $347 billion in 2000 to $1,208 billion in November 2014, an increase of $861 billion (IMF 2015). Furthermore, the holdings of foreign assets in Japan’s GPIF increased steadily in this period, reaching $308.8 billion in 2013, and are projected to increase to $480 billion or more in the near future (GPIF 2015).

Japan’s real effective exchange rate index declined steadily from 131.4 in 2000 to 74.5 in 2007, a decline of 43.3 percent (International Monetary Fund 2015). 2 During this period its current account balance, the broadest measure of Japan’s trade in goods, services, and income, increased from $130.7 billion (2.8 percent of its GDP) to $212.1 billion, or 4.9 percent of GDP (IMF 2014). Market forces and the Great Recession combined to push the yen up to a recent peak of 109.0 in 2012, a 46.2 percent increase since 2007. The rise of the yen and the 2011 Tōhoku earthquake and tsunami combined to push up Japan’s imports and suppress exports, creating a crisis in Japan’s trade and current accounts. Japan’s current account surplus shrank to $58.7 billion in 2012 and Japan developed its first global goods trade deficit in more than a decade, which reached $53.5 billion in that year (IMF 2015).

Japan’s trade and economic crises set the stage for the election of Prime Minister Shinzo Abe in December 2013 and subsequently gave his Liberal Democratic Party control of both houses of the Japanese Diet (parliament) in 2012 and 2013 (The Economist 2013). Abe is widely recognized for adopting a three-part plan for revitalizing Japan’s economy. The widely recognized parts of this plan included a substantial increase in government spending, liberalization of monetary policy, and deregulation of the Japanese economy.

Abe also stated his intentions to reduce the value of the yen shortly after his election. As noted in the Wall Street Journal at the time:

Mr. Abe … called on Japan’s central bank to resist what he described as moves by the U.S. and Europe to cheapen their currencies and noted that a yen level of around ¥90 to the dollar—it was at ¥84.38 in early Asian trading Monday, down from ¥84.26 late Friday—would support the profit of Japanese exporters. … “Central banks around the world are printing money, supporting their economies and increasing exports. … If it goes on like this, the yen will inevitably strengthen. It is vital to resist this,” said Mr. Abe. (Ito and Mallard 2012)

And resist it they did. The yen fell sharply as a direct result of Abe’s currency policies. Between the third quarter of 2012 and the end of 2014, the market value of the yen declined by 35.3 percent. 3 Japan’s real effective exchange rate index declined to 74.6 by the end of 2014, essentially the level that prevailed in 2007 when Japan’s current account reached a peak of $212.1 billion (4.9 percent of GDP). 4

Japan’s current account and trade balance remained suppressed in 2013 by several temporary factors, including the hangover from the Tōhoku earthquake and tsunami, increased demand for imports in anticipation of value-added tax increases taking effect in 2015, and the short-run impacts of the fall of the yen, which increased the cost of Japanese imports. Over the next few years the fall in the yen is expected to stimulate exports and suppress imports, resulting in growing trade and current account balances (as shown below).

Foundations of Japan’s currency policy

There are two key elements of Japan’s currency policy:

1. Maintain and increase foreign exchange reserves and government purchases of other foreign assets. In 2011, prior to Abe’s election, the Bank of Japan engaged in a massive, $185 billion purchase of foreign exchange reserves. This had no immediate impact on the value of the yen, which gained slightly against the dollar between the end of 2011 and the third quarter of 2012 (IMF 2015). However, maintaining a large stock of government-controlled foreign assets will have a strong, positive effect on Japanese trade accounts, due to portfolio balance effects. For Japan, which has a large and open private capital market, changes in the stock of foreign assets affect Japan’s trade flows with a lag, as shown below.
2. Increase holdings of foreign assets by Japan’s Government Pension Investment Fund. In November 2014 the GPIF announced its plan to increase target holdings of foreign stocks and bonds from 23 percent of its total $1.2 trillion dollars plus in assets in 2013 to 40 percent in the near future (Warnock and Narioka 2014). GPIF data show that the shift was already in progress in 2012 and 2013, and that actual foreign holdings exceeded even the 2013 target. Between 2012 and 2013 the GPIF increased its actual holdings of foreign assets from 21.4 percent ($244.2 billion) to 25.7 percent ($308.8 billion). While billed as a financial diversification effort, the GPIF announcement was also a public commitment to increase Japan’s total government holdings of foreign assets, which will have long-term impacts on Japan’s expected trade and current account surpluses.

Purchases and holdings of foreign exchange reserves by the Bank of Japan and of other foreign assets by the GPIF are the sine qua non of Japan’s currency policy. Without its massive holdings of foreign assets, and its continuing and periodic massive purchases of new foreign assets, the government of Japan would have been unable to prevent the yen from adjusting to levels consistent with trade and current account balances.

The United States needs to include in the TPP and any future trade or investment agreements currency disciplines that would compel Japan and other currency manipulators to divest themselves of excess holdings of foreign assets, or to otherwise be penalized or incur offsets to their currency manipulation. Absent such disciplines, the United States should not complete and Congress should not approve implementing legislation for the proposed Trans-Pacific Partnership or any future agreements. Without an effective currency agreement, the United States could be locked into a trade and investment treaty with Japan that would prohibit actions that are necessary to restore equilibrium to currency markets and rebalance trade with currency manipulators.

In the context of Japan’s continuing currency intervention, other policies implemented by the Abe government and the Bank of Japan have reinforced downward pressures on the yen. This has increased the importance of directly addressing currency manipulation by Japan. For example, by announcing in 2012 his intention to drive down the value of the yen, Abe sent a strong signal to financial markets that his government would penalize markets if the yen failed to depreciate.

In addition, Japan followed the lead of the United States and other countries in the wake of the Great Recession and engaged in quantitative easing (defined as central bank purchases of assets denominated in the host country’s own currency). While quantitative easing by the U.S. central bank had no significant long-term effect on the real value of the dollar, quantitative easing in Japan was significantly more extensive than in the United States, and contributed to the subsequent fall in the yen, but this effect was incidental to its primary purpose, which was to stimulate and reflate Japan’s domestic economy.

It is important to distinguish the effects of quantitative easing from currency intervention (defined as government purchases of assets denominated in foreign currencies). All countries should be free to engage in quantitative easing and other elements of domestic monetary policy, subject only to their own domestic policy goals and constraints (such as excessive inflationary pressure, as perceived by domestic authorities, as well as domestic employment and wage targets). Domestic monetary policies should not be labeled as part of currency manipulation, and they should not be constrained by international agreements. Prudential measures are appropriate to deal with short-term economic problems.

It does appear that large-scale quantitative easing in Japan has reinforced the fall of the yen, as noted below. The U.S. Federal Reserve should monitor these effects, and it may wish to consider limited, countervailing purchases of Japanese assets. But quantitative easing alone, in the absence of Japanese purchases and stockpiles of foreign assets, would be unlikely to disturb the long-term trend value of the yen.

With this background in mind, the following sections review each of the factors considered above and their implications for U.S.-Japan trade.

Japan’s foreign asset holdings

As noted above, on a global level, there is a near perfect correlation between official purchases of foreign exchange reserves and other foreign assets and the global current account surpluses of currency manipulators (Gagnon 2013, Figure 1). Recent research has shown that the stock of foreign assets also contributes to currency suppression and sustained current account surpluses (Bayoumi, Gagnon, and Saborowski 2014).

Estimates of Japan’s total holdings of foreign exchange reserves and other foreign assets are shown in Figure A. Estimated total foreign assets rose from $362 billion in 2000 to $1.7 trillion in November 2014, including targeted holdings of $480 billion, 40 percent of the GPIF’s $1.2 trillion in pension fund assets. 5 The latter is a significant increase in foreign asset holdings that will continue to suppress the value of the Japanese yen, and is expected to result in growing Japanese trade and current account surpluses, as shown below.