Trump administration is proposing tariffs on goods from countries found to have undervalued currencies, in a move that would further raise the heat of its assault on global trading rules amidst the trade war between China and the US.
According to the proposal, US-based companies will seek anti-subsidy tariffs on products from countries found by the Treasury Department to be engaging in competitive devaluation of their currencies.
An undervalued currency is one with an exchange rate lower than it is supposed to be. Currency can be undervalued particularly when its purchasing power, supply, and demand are all strong, but its price is still comparatively low.
Some governments keep their currencies undervalued deliberately because it makes their exports less expensive; however, this is usually an unsustainable policy.
At the moment, there is no country in the world that meets the criteria; however, it sets a wide standard by focusing on the undervaluation of currencies.
The trade war between the US and China can be attributed to President Donald Trump’s labeling the Asian country a currency manipulator.
Since then, his administration has been examining how to take a more aggressive approach to what is now a largely technical exercise by Treasury to determine whether any currency manipulation has taken place.
In defense, the US says that the move is set to put foreign exporters on notice that it can countervail currency subsidies that harm its industries.
What this means is that foreign nations would no longer be able to use currency policies to the disadvantage of others.
The notice released Thursday by the Commerce Department, says it would defer to Treasury in determining whether any currency was deemed undervalued.
It also specifically says the move is not aimed at any central bank action that results in currency swings.
“In determining whether there has been government action on the exchange rate that undervalues the currency, we do not intend in the normal course to include monetary and related credit policy of an independent central bank or monetary authority,” the US Commerce Department said.
Why Countries Devalue their Currencies
Currency devaluation has a strong impact on global markets. Of course, for many citizens of a country, the effect is felt during currency exchanges while traveling outside the country, but what does it mean for the economy?
Devaluing a country’s currency has its economic benefits. In other words, exporters become more competitive in the global market. Exports are encouraged while imports are discouraged.
Also, under a devalued currency economy, exports become cheaper and imports more expensive. This favors an improved balance of payments as exports increase and imports decrease, shrinking trade deficits.
Devaluing the home currency can help to correct the balance of payments and reduce these deficits.
According to Investopedia, a government may be incentivized to encourage a weak currency policy if it has a lot of government-issued sovereign debt to service on a regular basis.
If debt payments are fixed, a weaker currency makes these payments effectively less expensive over time.
The Bottom Line is…
Countries devaluing their currencies for various reason have to kiss the benefits goodbye. After all, the policy is highly unsustainable and it often fuels high inflation rates.
The policy creates uncertainty in global markets that can cause asset markets to fall or spur recessions thereby doing more harm than good.