Six years after the start of the Great Recession nearly 8 million jobs are still needed to return to prerecession labor market health (EPI 2013). Job creation should still be goal number one. Yet prospects for any fiscal policy action to boost jobs have disappeared under the weight of congressional dysfunction, and the Federal Reserve has begun to wind down monetary stimulus (Wall Street Journal 2013). But besides fiscal and monetary policy, there is a third tool of macroeconomic stabilization that could provide a huge boost to economic activity and job growth: realigning exchange rates to lower the U.S. trade deficit. The best part of this solution is that there is broad, bipartisan support for congressional action on this issue. In addition, under existing authority, the president can initiate policies that would make currency manipulation costly and/or futile. Together, these policies could lead to exchange rate movements that would create 2.3 million to 5.8 million jobs over the next three years by ending currency manipulation by a group of about 20 countries, with China as the linchpin. These actions would create jobs in every state and in most or all congressional districts. They would boost GDP, boost jobs and reduce unemployment, and actually reduce the federal deficit by spurring economic growth—all without direct budget costs. No other policies could achieve this economic trifecta.

Many of the new jobs would be in manufacturing, a sector devastated by rising trade deficits over the past 15 years. Rising trade deficits are to blame for most of the 5.7 million U.S. manufacturing jobs (nearly a third of manufacturing employment) lost since April 1998. Although half a million manufacturing jobs have been added since 2009, a full manufacturing recovery requires greatly increasing exports, which support domestic job creation, relative to imports, which eliminate domestic jobs. The overall U.S. goods trade deficit did decline slightly in 2012, to $741.5 billion, but the trade deficit in manufactured products increased by $10.2 billion in 2012, threatening manufacturing employment and the overall recovery.

Currency manipulation, which distorts trade flows by artificially lowering the cost of U.S. imports and raising the cost of U.S. exports, is the primary cause of these growing trade deficits. 1 Currency manipulation has increased global trade imbalances by between $700 billion and $900 billion per year, but the United States has absorbed the largest share. Halting global currency manipulation by penalizing or offsetting currency manipulation is the best way to reduce trade deficits, create jobs, and rebuild the economy.

This paper describes the positive effects of ending currency manipulation in three years by estimating the effects of reducing trade deficits on GDP, jobs, the federal budget deficit, and state and local budget deficits in 2015. This study is the first to estimate the job impacts of trade for the congressional districts served by the current 113th Congress, using new congressional districts based on the 2010 Census. Our research shows:

• Eliminating currency manipulation would reduce the U.S. trade deficit by $200 billion in three years under a “low-impact” scenario and $500 billion under a “high-impact scenario.” This would increase annual U.S. GDP by between $288 billion and $720 billion (between 2.0 percent and 4.9 percent).
• The reduction of U.S. trade deficits and expansion of U.S. GDP would create 2.3 million to 5.8 million jobs, reducing the U.S. jobs deficit by between 28.8 percent and 72.5 percent.
• About 40 percent of the jobs gained would be in manufacturing, which would gain between 891,500 and 2,337,300 jobs. Agriculture would also gain 246,800 to 486,100 jobs, heavily affecting some rural areas.
• Reducing trade deficits by eliminating currency manipulation would cost the federal government nothing; in fact, increased tax revenues and reduced safety net expenditures would reduce federal budget deficits by between $107 billion and $266 billion in 2015 (34.4 percent to 86.1 percent), and net state and local resources would increase by between $40 billion and $101 billion.
• Each of the 50 states and the District of Columbia would gain jobs in both the low- and high-impact scenarios. Job gains in the low-impact scenario would range from 1.06 percent of state employment in Washington, D.C. to 2.29 percent of employment in Wisconsin. Job gains in the high-impact scenario would range from 2.64 percent in Washington, D.C. to 5.55 percent in Wisconsin.
• Nine of the top 10 states gaining the most jobs (as a share of total employment) in both scenarios are in the Midwest, including six states where manufacturing predominates: Wisconsin (64,700 to 156,600 jobs), Indiana (61,000 to 152,600 jobs), Iowa (34,000 to 79,600 jobs), Minnesota (55,900 to 135,300 jobs), Michigan (82,800 to 207,200 jobs), and Ohio (103,200 to 254,600 jobs); and three states that also benefit from manufacturing and/or agricultural job growth: South Dakota (9,200 to 21,100 jobs); Kansas, a major producer of aircraft and parts (28,900 to 67,000 jobs); and Nebraska (19,000 to 44,200 jobs). In the West, Idaho, a significant employer in computer and electronic parts production (13,900 to 32,700 jobs), rounds out the top 10 states gaining the most jobs.
• Jobs are gained in most congressional districts in the low-impact scenario, and in all congressional districts in the high-impact scenario. In the high-impact scenario, each of the top 20 districts by jobs created as a share of district employment would gain at least 14,700 jobs and as many as 24,400 jobs (gains representing between 5.79 percent and 8.65 percent of total district employment). Of the top 20 congressional districts, five are in California; three are in Wisconsin; two each in Indiana, Ohio, and Michigan; and one each in Kansas, Nebraska, Illinois, Minnesota, Washington, and Iowa. In the high-impact scenario, among all districts net job gains range from a low of 6,300 jobs in the 34th Congressional District in California to a high of 24,400 jobs in the 17th Congressional District in California.

The paper reviews the causes of currency manipulation and recommends three steps for bringing it to an end. First, Congress should pass pending legislation (H.R. 1276 and S. 1114) that would allow the Commerce Department to treat currency manipulation as a subsidy in Countervailing Duty trade cases (nearly identical legislation was passed by large majorities in the last three years but never enacted). Second, as a majority of the House has insisted, the proposed Trans-Pacific Partnership (TPP) trade agreement should include “strong, enforceable currency manipulation provisions.” Third, the administration must implement strategies that would tax and/or offset purchases of foreign assets by currency manipulating governments, which would make efforts to manipulate the dollar and other currencies costly and/or futile.

Background: Exchange rates, trade, and currency manipulation

Ending currency manipulation is the best possible means available for rebalancing global demand, reflating the U.S. economy, and ending the jobless recovery. Addressing currency manipulation requires understanding how exchange rates are set and the tools available to discourage or offset currency manipulation.

Exchange rates

Exchange rates measure the value of a country’s currency relative to other currencies (Nelson 2013). The nominal exchange rate is simply the rate at which one currency can be exchanged for another. On November 1, 2013, one U.S. dollar (USD) could be exchanged for 6.1 Chinese yuan (CNY), 2 1,060.9 Korean won (KRW), 98.8 Japanese yen (YPY), or 0.91 Swiss francs (CHF) (Board of Governors of the Federal Reserve System 2013). Exchange rates can be expressed in home or foreign currency units. Thus, the exchange rate between dollars and Chinese yuan on November 1, 2013, can be expressed as 0.164 USD/CNY or, identically, as 6.1 CNY/USD.

If the exchange rate is expressed in terms of USD per unit of foreign currency, then increases in the exchange rate reflect a rising value of the foreign currency, and vice versa. Or put differently, up is up, and down is down. This paper will refer to exchange rates in terms of USD per unit of foreign currency. Thus, an increase in the value of the yuan would be reflected in an increase in the USD/CNY exchange rate.

Exchange rates are used to calculate the value of foreign goods, services, and assets in terms of U.S. dollars. Thus, consumers and businesses in the United States use exchange rates to compute the cost of Japanese and Korean cars in terms of U.S. dollars. In the same way, consumers and businesses in Japan and South Korea use exchange rates to calculate the cost of U.S. cars in Japanese yen or Korean dollars.

Exchange rates are determined by the relative supply and demand for currencies in foreign exchange (FX) markets. The relative demand for currencies is determined by the demand for goods, services, and assets denominated in each currency. Large international capital flows can have a major influence on the relative demand for individual currencies. Trading in global FX markets was $5.3 trillion per day in April 2013, a substantial increase from the $3.3 trillion daily trading average in April 2007 (Nelson 2013, 3). However, a large share of such daily international currency transactions consist of two-way trades in financial derivatives, currency swaps, and other hedging devices that rarely affect market exchange rates.

Recent research has shown that net private financial flows are poorly correlated with the level of exchange rates, an indication that financial markets are not operating efficiently (Gagnon 2013). There are periods, of course, when even private financial flows can be destabilizing and lead to large trade imbalances—and policymakers should certainly have, and be willing to use, tools to fight this. However, the current constellation of trade imbalances is primarily the result of governments that use intentional policies, especially official purchases of foreign assets (public financial flows), to influence exchange rates (Gagnon 2013). This issue is discussed in more detail below.

Effects of exchange rates on trade

The price of all a country’s exports and imports are strongly influenced by the exchange rate; it is one of the most fundamental prices in the economy. Therefore, changes in the exchange rate can have a large impact on the level of imports and exports, and on the trade balance. When a country’s exchange rate declines, relative to other currencies (a depreciation or devaluation 3 ), its exports become cheaper in foreign markets, and imports from other countries become more expensive. Over time, devaluation will increase the level of exports and reduce the level of imports. 4

Thus, if the Chinese yuan is devalued against the U.S. dollar, Chinese exports become cheaper in the United States, and U.S. exports become more expensive in China. This will increase U.S. imports from China, and U.S. exports to China will fall. A devaluation of the yuan also lowers the relative cost of China’s exports in every country where it competes with U.S. exports (and China is the most important competitor of the United States in third-country markets). Thus, devaluation of the yuan by China will also tend to reduce U.S. exports to the rest of the world, and increase the U.S. trade deficit with China and the world as a whole.

Exchange rate regimes and currency manipulation

There are two basic policy approaches countries can take toward exchange rates (Nelson 2013, 4–6). Some countries “float” their currencies, allowing the price or value of the currency to be determined by supply and demand in FX markets. Under a pure floating regime, governments do not “intervene” by taking policy actions to determine or guide the value of their currencies. In 2012, over a third (35 percent) of countries “had floating currencies… includ[ing] major currencies, such as the U.S. dollar, the euro, Japanese yen, and the British pound, whose economies together account for 50% of global GDP” (Nelson 2013, 5).

Other countries “fix” or “peg” their exchange rates, setting a fixed value for their currency relative to another, major currency (such as the U.S. dollar), or relative to a group or basket of currencies, or to a commodity such as gold or silver. The government, usually the central bank, uses a variety of tools to manage the supply of and demand for its currency in FX markets to achieve the target price for the currency. Central banks often “maintain exchange rate pegs by buying and selling currency in international markets, or ‘intervening’ in FX markets” (Nelson 2013, 4).

Governments usually intervene in FX markets by purchasing foreign assets such as treasury bills, which are usually held by the central bank as FX reserves. Some governments also have sovereign wealth funds (SWFs) which sometimes invest in foreign stocks and other private-market assets (e.g. land, access to natural resources) (Bergsten and Gagnon 2012).

Purchases of foreign assets by central banks and other government agencies, including SWFs, over any period of time, are a key measure of FX intervention. Central banks often report total holdings (stocks) of reserves, including FX, at year-end. 5 Changes in the stock of total reserves are thus used as an indicator of foreign currency intervention. When the People’s Bank of China (its central bank) purchases U.S. treasury bills, this increases demand for U.S. dollars, putting upward pressure on the dollar and depressing the Chinese yuan.

Purchases of foreign assets represent a flow of capital out of the investing country. For example, by purchasing U.S. treasury bills, China is lending money to the United States. Legitimate questions have been raised about the wisdom of such loans from a developing country, where rates of return on public and private investment are likely very high, to a large developed country where capital is much more plentiful and interest rates are much lower.

As Nelson (2013) notes, in practice, a few smaller countries use a “hard” peg that anchors the value of the home currency to another, including countries such as Ecuador, which uses the U.S. dollar as its national currency. Overall, in 2012, about 13 percent of countries maintained a hard currency peg, and 40 percent of countries used a “soft” peg, which lets the exchange rate fluctuate within a desired range (Nelson 2013, 5). Many of these countries buy and sell FX reserves and otherwise intervene in capital markets as needed to maintain their exchange rate within a target band.

Defining currency manipulation and differentiating it from quantitative easing

Not all countries that peg their currency are considered currency manipulators. Currency manipulators accumulate growing FX reserves over time, whereas other countries (for example, Brazil or India) both buy and sell reserves, as needed, to maintain the target exchange rate. Currency manipulators also maintain large and growing trade and current-account surpluses, relative to GDP. (The current account is the broadest measure of the overall balance of a country’s trade in goods, services, and other income, e.g. profit and interest payments, and outflows, e.g. foreign aid.) According to Bergsten and Gagnon (2012, 5) currency manipulators are countries that meet the following four criteria:

• They held FX reserves that exceeded six months of goods and services imports.
• They maintained a total (global) current-account surplus between 2001 and 2011.
• Their total FX reserves grew faster than their GDP between 2001 and 2011.
• They have gross national income in 2010 of at least $3,000 per capita, the median among 215 countries ranked by the World Bank (this criterion excludes low-income developing economies).

The first criteria accounts for countries that do not maintain a purely floating currency but have valid, precautionary motives for maintaining financial reserves, and a widely accepted standard target for reserves is three months of goods imports (IMF 2011).

These criteria also account for how the growth of international capital flows has made it increasingly difficult for many smaller and developing countries to maintain stable exchange rates, which can be buffeted by changes in underlying business cycle conditions (booms and busts) or by the development of mineral or agricultural resources. These countries have been particularly hard hit by currency manipulation by large trading countries such as China, Korea, and Japan, which has made it difficult for other developing countries to compete in international markets. Dozens of smaller countries have been forced to intervene “on a smaller scale, mainly as a defensive reaction” to remain competitive internationally (Bergsten and Gagnon 2012, 1).

Some countries have complained that quantitative easing (QE) by central banks in large countries such as the United States and United Kingdom, and in the eurozone, has caused their exchange rates to rise (Reuters 2010). However, there is a clear, substantive distinction between QE and currency manipulation. Currency manipulators make large purchases of foreign assets, which has the first-order effect of changing exchange rates and influencing foreign demand for a country’s output. However, central banks in the United States and the eurozone buy and sell assets denominated in their own currencies. with the aim of changing domestic interest rates, which directly affects domestic demand. While the interest rate changes do have possible spillover effects on exchange rates, if all countries undertook QE, there would be no net change in exchange rates or trade flows. That contrasts with a situation where one country—say, China—purchases the foreign assets of another—for example, the United States—and does not have open capital markets that allow a reciprocal purchasing of Chinese assets by U.S. investors or the Fed.

Identifying the currency manipulators

Overall, at least 20 to 25 countries that employ a “soft” currency peg are actively managing or manipulating their exchange rates in order to maintain or increase trade and current-account surpluses. But not all of these countries are currency manipulators. Bergsten and Gagnon identify 20 countries that have substantial excess reserves and meet the criteria outlined in the previous section. Collectively, over the last few years, these countries have been investing nearly $1 trillion per year on average in FX reserves to maintain large trade (and current-account) surpluses. Over the past decade, there is a near-perfect correlation between FX purchases by these countries and their collective current-account surpluses (Gagnon 2013, Figure 1). 6

China is by far the largest holder of total FX reserves, both in terms of the size of its reserve fund and its economic impact on global trade flows. But several other Asian countries and oil-exporting nations, as well as a few countries in Europe, have also intervened heavily in FX markets. Total FX reserves equaled 45 percent of China’s GDP at the end of 2011. The reserve share of GDP was comparable for other currency manipulators such as Switzerland (43 percent) and Malaysia (46 percent). It was substantially higher than the Chinese level in Azerbaijan (53 percent), Qatar (58 percent), Taiwan (83 percent), Saudi Arabia (91 percent), Algeria (95 percent), Norway (113 percent), Hong Kong (118 percent), Kuwait (133 percent), Singapore (187 percent), and the United Arab Emirates (216 percent) (Bergsten and Gagnon 2012, Table 1 at 3).

China’s estimated, self-reported, current-account balance fell to 2 percent of GDP in 2012. Other currency manipulators had current-account surpluses that were much larger, relative to output, such as Taiwan (7 percent), Malaysia (8 percent), Switzerland (10 percent), Norway (15 percent), and Singapore (21 percent). Many oil-exporting countries had much larger current-account surpluses, ranging from Saudi Arabia (26 percent) and Qatar (30 percent) up to Kuwait (44 percent) (Bergsten and Gagnon 2012, Table 1 at 3).

However, China dwarfs all other currency manipulators in terms of its total global current-account surplus, and total FX holdings, due in part to the size of its economy. Among all currency manipulators, China had the largest 2012 current-account surplus ($191 billion), as estimated by the IMF (Bergsten and Gagnon 2012, Table 1 at 3). Furthermore, trade data from the United Nations Comtrade program suggest that China has been substantially underreporting its trade and current-account surpluses for at least the last six years. Adding up the bilateral trade balances reported by all of China’s trading partners yields annual estimates of China’s global goods trade surpluses that for recent years are as much as twice as large as those reported by China, as shown in Figure A .