Treasury's plan backfires as IMF targets dollar's overvaluation instead of yuan's


By Christopher Swann
Bloomberg News Service
Thursday, August 23, 2007

WASHINGTON -- The U.S. Treasury took two years to persuade the International Monetary Fund to police global currency markets -- and just two months to trash the initiative once the IMF adopted it.

Treasury officials recruited the IMF to be a currency cop as China and other countries meddle with exchange rates to gain a trade advantage. Instead, the international lending organization took aim at the dollar, calling it overvalued in an Aug. 1 report. The Treasury objected, and on Aug. 2 an aide to Treasury Secretary Henry Paulson told Congress that it's impossible to measure a currency's fair value.

"The U.S. Treasury has cut the legs from under the IMF before it even started the race," said Michael Mussa, the IMF's chief economist from 1991 to 2001 and now a fellow at the Peterson Institute in Washington. "This was foolish and unnecessary when they could have just said nothing."

By rejecting the IMF's analysis, the Treasury may have jeopardized its own effort to use international leverage to help narrow China's $118 billion trade surplus with the U.S. Members of Congress are threatening sanctions if the Treasury doesn't succeed in getting China to stop suppressing the value of its currency.

Chinese authorities have limited the yuan's advance against the dollar to about 9 percent since July 2005, when officials ended a strict peg to the dollar. By comparison, India's rupee has climbed 8 percent this year alone.

Legislators including Rep. Sander Levin of Michigan, a Democrat who chairs the trade panel of the House Ways and Means Committee, have said the yuan is undervalued by as much as 40 percent.

The IMF was established in 1945 by United Nations conferees to provide emergency loans and surveillance in times of economic crisis. Funding comes from its 185 member countries.

As the need for loans has faded and global trade expands, the U.S. has urged the IMF to use its resources to monitor currency policies that distort trade flows.

Tim Adams, then Treasury undersecretary, kick-started the process in September 2005 when he blasted the IMF for a perception it was "asleep at the wheel on its most-fundamental responsibility: exchange-rate surveillance."

Involving the IMF also served a political purpose: It helped to disengage the U.S. from a direct confrontation with China over the value of the yuan, which the U.S. argues is undervalued as a result of Chinese government policy. Now the Treasury's response to the IMF's analysis of the dollar may undermine the lender's ability to referee currency disputes.

IMF staff economists told U.S. officials in meetings ended July 27 that their research showed the dollar was 10 percent to 30 percent overpriced, according to an account included in the 54-page Aug. 1 report.

Treasury officials criticized the IMF analysis for relying too much on trade in goods and services and not enough on capital flows. While the U.S. has run record trade deficits in recent years, foreign capital also continues to flow into the country at an even stronger rate.

The Treasury also was "skeptical about the notion of overvaluation for a market-determined exchange rate such as the dollar," the report said.

The second blow to the IMF's new mission came when Mark Sobel, a Treasury deputy assistant secretary, told Congress Aug. 2 that, while exchange-rate modeling offers "valuable insights, there is no reliable or precise method for estimating the proper value of an economy's foreign-exchange rate."

Treasury Assistant Secretary Clay Lowery, the department's No. 2 international official, said the U.S. stance on calculating fair-value rates isn't new and doesn't undercut the IMF. Pinpointing an exchange rate's fair value is "very difficult," Lowery said in an interview. "The IMF explained what they believed, and the United States explained back what it believed on the same issue."

Angela Gaviria, an IMF spokeswoman in Washington, declined to comment.

Armed with the Treasury's arguments, China may now emulate the U.S. by rebuffing IMF attempts to alter its exchange-rate policies. China, along with Iran, voted against the fund's new surveillance program before IMF Managing Director Rodrigo de Rato unveiled it in June.

"The U.S. criticism will certainly weaken the authority of the fund to comment on China's currency," said Adam Lerrick, a professor of economics at Carnegie Mellon University in Pittsburgh. "The Chinese are likely to argue that the fund is wrong about their currency too, and point out that even the U.S. doesn't trust the fund's views."

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