The Coming Interest Rate Increases and Dollar Depreciation
By JC Collins
The Trans-Pacific Partnership is being promoting as an opportunity for the United States to boost exports and create more domestic jobs. The reluctance of most Americans to accept this salesmanship at face value exists for good reason.
Trade agreements of the past, such as NAFTA, have not particularly benefitted the average citizen of the United States, Canada, or any other country that has entered into FTA’s of any sort. With that being said, one of the main reasons for the continued disparity of past trade agreements is centered on the inability of authorities to address exchange rate manipulation and currency mismanagement.
The International Monetary Fund and World Trade Organization have no real means of enforcing rules around currency manipulation. The domestic management of such macroeconomic policies are the responsibility of each nation’s financial department, or treasury. All of which are operated separate from the legislative powers in government, such as the Executive Branch and Congress.
It is assumed that the TPP does not contain a currency management provision and similar currency and trade imbalances which existed under past trade agreements will also skew the effectiveness of the TPP. Considering the level of secrecy surrounding the agreement, it is probable that there could be such a provision included in the draft versions of the agreement, but that knowledge is not widely known.
This would explain the legal commitment required of those who read the agreement not to disclose what is contained within the draft. Market effects from the level of exchange rate management and adjustments required to make the TPP sustainable could potentially be volatile. The need to manage the release of information surrounding TPP, and integrating it with other macroprudential policies which are related, will be one of the more challenging aspects of its full implementation.
Outside of fear mongering and repeating the same script of negativity surrounding the agreement, let us review the TPP through logical deduction and attempt to understand the main source of contradiction which has polarized both sides of the debate.
The Trans-Pacific Partnership cannot be understand in isolation from the rest of the multilateral framework which is being negotiated and implemented internationally. As such, the TPP will define the path forward for multilateral trade liberalization.
Trade agreements of the past have not addressed exchange rate management and currency disparity. The effects of this have largely been felt by the middle class, as exchange rates of foreign currencies have allowed for a flight of investment capital to emerging markets where goods could be produced for cheap and imported back into the domestic economy at exorbitant profits.
The loss of jobs under agreements such as NAFTA have been staggering. Based on this experience the expected losses under the TPP are assumed to be greater than. But that may not be necessarily true.
In order for the United States to experience the desired increase in exports, the dollar will have to experience some level of depreciation. This reality is interwoven within the multilateral framework of such agreements as the TPP and the AEC in Asia.
Exchange rates can affect trade flows and trade balances. Considering the balance of payments deficit which the United States built by holding the worlds primary reserve currency, it can be expected that as the reserve currency status is shifted to a multilateral SDR framework, the US dollar will depreciate to allow for a swing in the balance of payments from deficit to surplus, or a balance between both.
This balance between trade surplus and trade deficit will be a direct product of managing exchange rates and reducing currency manipulation. This balance will allow for a more competitive environment between nations as multilateral trade agreements such as the TPP will reduce and eliminate restrictions on trade, such as tariffs.
The United States, when faced with trade deficits and a loss of jobs, has done very little to force a solution to currency manipulation and disparity in exchange rates. There are multiple reasons for this, but none more so than the fact that the USD could not be allowed to depreciate as long as it was still the reserve asset used internationally.
When the multilateral is more fully implemented and the SDR becomes the supra-sovereign reserve asset, the US will be in a position to demand that exchange rate management be addressed. This will force the appreciation of other currencies and a depreciation of the USD in efforts to balance trade surpluses and trade deficits.
The downside to such a multilateral trade and exchange rate liberalization will be the reduction in sovereign control over domestic economies. This is the one fear which has likely driven the negative reactions to the TPP, and for good reason.
The US, expecting a depreciation of the dollar for the purpose of increasing exports, will have to accept the same rules of currency manipulation and exchange rate management as other countries in the agreement.
When the Federal Reserve increases interest rates later this year, the expected appreciation of the dollar would normally follow. Higher interest rates will increase the demand for the dollar and lead to appreciation. This appreciation will not help America achieve the goal of increased exports, and will put greater strain on the valuations of the currencies of emerging markets, such as China and India.
The TPP, which neither China nor India are included within, will have to ensure exchange rate management for those countries who are included, which are:
United States, Australia, Brunei, Canada, Chile, Japan, Malaysia, Mexico, New Zealand, Peru, Singapore, and Vietnam, some of whom are also members in the AEC trade agreement.
The framework of the multilateral monetary system, which intends to correct the balance of payments deficits, will need to be coordinated with the negotiation and implementation of the Trans-Pacific Partnership, along with the AEC. The interest rate of the USD is directly tied to the TPP and the corresponding depreciation and multilateral exchange rate management.
The TPP will be followed by the TTIP, Transatlantic Trade and Investment Partnership, which will be a similar agreement between the United States and the European Union.
Both agreements will be structured around exchange rate management which will ensure that an increase in interest rates in America will not be followed by dollar appreciation, but by depreciation, which will be built within the exchange rate management structure of the TPP and TTIP.
That is the probable reason for secrecy around the negotiations and ratification of the agreement. It is expected to be ratified in July, but its full implementation will correspond with the start date of the AEC in Asia on January 1, 2016. Which is also the date the new SDR composition also comes into effect. – JC