The Self-Serving Argument That Could Sink the Pacific Trade Deal

Congressmen cry foul over currency intervention -- until the U.S. does it.

Hundreds of Congressmen, dozens of Senators, and America's three big automakers have all slammed the Obama administration's giant trade deal. That’s because the 11 other countries in the so-called "Trans-Pacific Partnership" all manipulate their currency and subsidize critical industries, the critics say.

The small problem with the argument? Other countries contend that America manipulates its currency, too -- by printing money again and again and again. And America occasionally subsidizes the odd industry, too. Just ask executives at the big automakers, which took massive U.S. bailouts after the financial crisis of 2008.

President Barack Obama made trade a central part of his strategy to revive the U.S. economy when he set the ambitious goal of doubling exports over five years, in his 2010 State of the Union address. Export numbers are going up, but they’re not on track to hit that target. Securing a trade deal that includes fast growing emerging market economies could move the U.S. closer to that goal, if the Obama administration can get Congress to pass the deal.

But so far, they can't. These arguments from Congress and the car-makers are a big reason why.

Most countries agree that manipulating your currency is bad, but they also agree that sovereign governments should have control over their currencies and be able to print money as they like. Both the U.S. and Japan have been employing “easy money” policies to support their domestic economies over the past few years since the financial crisis. Making a distinction between that and intentional manipulation is very difficult.

"When other countries push down the value of their currency it’s currency manipulation, when our central bank dumps dollars into the system that’s supposedly ok because it’s supposedly for good reasons," said Derek Scissors, a resident scholar at the American Enterprise Institute.

U.S. politicians often use the idea that other countries manipulate their currencies as a way of explaining why the U.S. economy is suffering. Some observers of the trade negotiations see the currency complaint as a proxy for other concerns, like the auto industry’s desire to protect a 25% tariff on trucks that are imported to the U.S.

"They’re just demanding carve outs like they got with the Japanese on trucks already,” Scissors said.

And this is where it gets complicated. One part of the deal could be a gradual decrease in the tariff that currently applies to trucks imported to the U.S. from Japan and other countries.

"The truck tariff is 25 percent; it’s a legacy of the Chicken War we had with the Germans in the 1960s," said Bill Reinsch, the President of the National Foreign Trade Council, which represents 300 companies, including automotive, technology and financial companies. In 1964, President Lyndon B. Johnson slapped the tariff on truck imports in retaliation for a tariff that the German government put on U.S. chicken imports.

That’s just one of the many issues the Obama administration is trying to work out in a series of negotiations around the world running through the end of the year. The administration is also facing criticism for not being transparent about the negotiations. A draft of the intellectual property chapter of the deal released by Wikileaks last week drew further calls for openness amid complaints from consumer advocates that the deal was giving too many concessions to corporate interests. It’s hard to tell whether the administration will meet its end of year goal, but the auto industry isn’t likely to be the last one to trot out a list of demands.

"When you come to the final stages of these negotiations you always hear from specific firms and organizations that want to see certain things in the deal,”said John Murphy, from the Chamber of Commerce.

Take the automakers, who are worried that other countries (specifically Japan) will drive down their own currency in order to make it cheaper to sell their cars and trucks to other countries. Auto lobbyists say that’s unfair.

"It artificially lowers the cost of other countries exports and that makes it more difficult for people that make things in the United States to compete," Matt Blunt, President of the American Automotive Policy Council. Blunt said that if the U.S. doesn’t include provisions to deal with this problem, the Council -- which represents Chrysler Group LLC, Ford Motor Company and General Motors Company -- won’t support the trade deal. Yes, that’s right. American auto companies -- beneficiaries of an $80 billion government bailout after the financial crisis – are objecting to other governments helping their domestic companies.

Lots of lawmakers (230 representatives and 60 Senators) have written letters raising the issue of currency manipulation. Michigan Democrat Rep. Sandy Levin, who sits on the powerful Ways and Means Committee, has put forward a proposal to create a panel to judge whether countries are artificially depressing their currencies.

"There is no point in negotiating a TPP agreement to eliminate import duties if countries are allowed to effectively reimpose those duties by manipulating their currencies," Rep. Levin said in a statement.

The provision is not seen as likely to be adopted because other countries would object. It's not just that America is seen as a hypocrite on this issue. It’s also just hard to determine objectively when a currency is over-valued or under-valued, which makes it a subjective and politically-charged topic.

"Leaving those issues to be determined by an ad hoc panel that’s pulled together…is a pretty a tall order," said John Veroneau, a partner at Covington & Burling LLP and former Deputy U.S. Trade Representative. Big international organizations like the International Monetary Fund and the World Trade Organization have grappled with the topic, but haven’t come up with a way to satisfy the concerns of all involved.

Reinsch, from the National Foreign Trade Council, added: "No one has ever come up with an objective, agreed upon way to think about that."

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The Next Big Financial Scandal

A mounting investigation into the foreign exchange market could be the next black eye for the financial industry.

At Wall Street's annual trade conference this week, the common refrain for addressing the industry's marred public image was "stay out of the newspaper." So much for that. Many of the world's biggest banks are now caught up in another sprawling inquiry that is likely to keep them in the headlines for months, and possibly years, to come.

J.P. Morgan, HSBC, and Barclays have all said they're under investigation by authorities looking into possible collusion to manipulate foreign exchange markets. The Financial Times reported Wednesday that 15 banks, including Citigroup, Morgan Stanley, and UBS, have also received requests to turn over information to British regulators, who are among the seven authorities involved in the probe. U.S. authorities are also involved.

"The manipulation we've seen so far may just be the tip of the iceberg," U.S. Attorney General Eric H. Holder told the New York Times. "We've recognized that this is potentially an extremely consequential investigation."

One of the consequences could be a re-examination of how the foreign exchange market works. Right now, it is an opaque market controlled by the world's biggest banks without a lot of regulatory oversight. After the financial crisis, policymakers decided certain parts of the financial system should be more transparent, such as previously dark derivatives markets. But regulators decided to leave the foreign exchange market alone, as it was it was seen as functioning well during the chaos of the financial crisis.

If the inquiries are fruitful, banks could be facing another embarrassing, expensive scandal. The global foreign exchange market is worth trillions of dollars, so any manipulation could affect people all around the world. That means banks could face private lawsuits, in addition to charges or fines from authorities in different countries.

The mounting investigation is the latest in a series of regulatory inquiries into benchmarks that are set by a relatively small group of bankers, but affect wide swaths of the financial system. Regulators have already looked at benchmarks that underpin markets in everything from gold to interest rates.

Benchmarks were once a little-considered cog in the financial system, until the banks started paying record-setting penalties to settle the accusations that they were manipulating these rates. UBS paid $1.5 billion, admitted to manipulating the London Interbank Offered Rate (Libor), and two of the bank's former traders are facing criminal charges. Libor is supposed to be the interest rate at which the 16 biggest banks lend money to each other. Loans and financial contracts all over the world -- from large-scale contracts to mortgages -- are tied to that rate. But regulators discovered that traders often submitted false rates in order to benefit their positions or make the bank's credit look better than it was.

Chat room conversations filled with emoticons and offers of champagne made it clear the Libor and other interest rate benchmarks were widely being manipulated. For instance, on March 3, 2010, a Royal Bank of Scotland trader asked the guy who submits the bank's rate to the benchmark-setter if he could change his submission for "a mutual friend." "If u cud see ur way to a small drop there might be a steak in it for ya," the trader said to the submitter, according to a complaint filed by regulators. RBS has already paid over $600 million to settle charges related to that complaint.

And this could just be the beginning because benchmarks are used in lots of different markets -- including metals, currencies, and oil -- as a way of gauging a fair price when transactions are private. For instance, if you want to buy a share of a publicly traded stock, you can look at a stock exchange and see what the current price is for the company's stock that you want to buy. With currencies, for example, it's not nearly that simple. Currencies are traded in banks all over the world. So, if you want to trade in $500 million for euros, you could call the 10 biggest banks and ask them to quote you a price or you could use a benchmark, where a middleman does the work for you. A company or an organization takes a survey of prices from different bankers or brokers and then takes the average, so that as a buyer you can have a better idea of what's a good price.

The problem is that the prices are often being reported by a relatively small group of people who stand to benefit if the price moves one way or the other. Traders could also benefit by moving a rate higher ahead of a large customer order they know will be pegged to a particular benchmark. But it's not just about moving the benchmark higher. Through side bets using financial contracts called derivatives, a very small move one way or the other can be magnified into a large pay out.

And so we've got a new, fast-spreading investigation ramping up into currency benchmarks. The Libor scandal rocked the banking world -- banks have been fined billions of dollars, executives have resigned. There's not telling how big of a mess this new probe could uncover. Among other things, regulators are looking at a group of senior foreign exchange traders who were widely known amongst other traders as "The Cartel," Bloomberg reported in October. Regulators are focused in particular on one benchmark which is compiled by the WM Company and Thompson Reuters. The WM Company "currently collects, validates and publishes" benchmark exchange rates for all the major currencies, according to the company's website. If authorities turn up more chatter of traders blithely manipulating these benchmarks, it will present another black eye for the industry, just as it's trying to put the Libor scandal behind it.

Manipulation cases in the foreign exchange market could also raise questions about whether the market is properly regulated. It's a global, decentralized market with transactions taking place in banks all over the world, but there isn't a global regulator to oversee it.

"National regulators have oversight over national markets, but this has been a global market forever," said Richard Lyons, dean of UC Berkeley's Haas School of Business. Lyons says that's part of the reason the market has only seen "light touch" regulation.

U.S. regulators and policymakers considered further regulation for the foreign exchange market after the financial crisis, but concluded that it was unnecessary because most of the players in the market are banks, which are already heavily regulated.

"The market for foreign exchange transactions is one of the most transparent and liquid global trading markets," the Treasury Department said in November 2012, when it decided to exempt foreign exchange derivatives from new rules for derivatives put in place after the financial crisis. "Existing practices already help limit risk and also ensure that the market functions effectively," Treasury said in its determination.

It's not clear that those rules would have prevented wrongdoing by individual traders, but if a raft of manipulation cases comes down, regulators may decide to revisit the idea of greater oversight.