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.The implication, ofcourse, is that the renminbi is currently undervalued and that China needsto revalue the currency upward in order to be able to cease such large-scale purchases and to be in full compliance with Article IV.These four steps would be advanced in parallel and hopefully wouldlead to agreement to curtail currency manipulation to gain an unfaircompetitive advantage.The question remains, however, as to what theUnited States and other adversely affected trading partners should do ifcurrency manipulators ignore the bilateral and IMF admonitions andcontinue their manipulative exchange rate policies.Under such circum-stances, a contingent fifth step would be taken in the World Trade Organi-zation (WTO).Step 5: WTO dispute settlement.The General Agreement on Tariffs andTrade (GATT) Article XV, now incorporated within the WTO, addresses Exchange Arrangements, and stipulates that members should not takeexchange rate actions that frustrate the intent of the provisions of thisAgreement. The intent of the Agreement, in turn, as stated in broadestterms in the Preamble, is the objective of entering into reciprocal and10.The IMF publishes global official holdings by currency in September for the previousyear, or nine months after the fact, but without a breakdown in such holdings by mem-ber country.280 DOLLAR OVERVALUATION AND THE WORLD ECONOMY mutually advantageous arrangements directed to the substantial reduc-tion of tariffs and other barriers to trade. Clearly, exchange rate manipu-lation that results in a $100 billion per year larger US trade deficit thanwould otherwise occur frustrates such reciprocal and mutually advanta-geous arrangements.The United States could thus file a complaint withinthe WTO dispute settlement mechanism against recalcitrant currencymanipulators.GATT Article XV also provides for full consultation withthe IMF, including that members shall accept all findings of statisticaland other facts presented by the Fund relating to foreign exchange, whichwould link any such US initiative in the WTO to prior IMF consultations asdescribed in step 4.This is the five-step policy response readily at hand.Step 5 shouldclearly be held in reserve, to be avoided if at all possible, but at the sametime the United States should not be hesitant to state that it would beobliged to pursue this course if other actions proved fruitless.The rationalethroughout all steps of the policy response would be derived from theadverse impact on US interests described earlier.Currency manipulationto gain an unfair competitive advantage has simply become too importantan issue within the evolving international financial system to ignore anylonger, and the practice therefore needs to be sharply curtailed or elimi-nated.Epilogue: Systemic ImplicationsThis chapter has been about currency manipulation and its direct impacton exchange rates and the US trade deficit.The issue of currency manipula-tion has broader implications for the international financial system as itevolves into a two-corner system of floating exchange rates and mone-tary unions.11 In this context, a thorough appraisal of currency manipula-tion leading to its sharp curtailment or elimination would constitute amajor step forward for realizing such a system within a cooperative multi-lateral framework.The international financial system has been essentially undefined forthree decades.The dollar fixed-rate system created at Bretton Woodsended in 1971 when the United States closed the window on dollar con-vertibility into gold.This precipitated a potpourri of exchange rate rela-tionships from fixed to floating rates, with various forms of adjustablepegs and currency bands in between.The lack of systemic definition washighlighted in 1994 at the 50-year anniversary of Bretton Woods, whena Bretton Woods Commission group of 47 distinguished financial leadersand experts, chaired by Paul Volcker, called for the establishment of a11.The evolving two-corner system is analyzed in detail in Preeg (2000a), especially chapters2 and 9.EXCHANGE RATE MANIPULATION 281 new system.[because] the alternative to a new global system is tocontinue the present nonsystem. The commission report had little tooffer, however, as to what form the new system should take except to notethat this system could possibly involve flexible exchange rate bands. Five months later the Mexican peso crashed through the bottom of itsdollar exchange rate band, and financial markets assumed the lead role inpushing governments toward a truly new postdollar floating rate system.Subsequent financial crises in Thailand, Indonesia, South Korea, Russia,Brazil, Turkey, and Argentina all resulted in shifts from some form ofdollar-linked currencies to floating rates.Meanwhile, in the other mone-tary union corner, the European Monetary Union was launched and moremodest steps were taken toward dollarization.12The outstanding and indeed critical question for this new, predomi-nantly floating rate system is to what extent the floating rates will be managed through official intervention in currency markets.Will ratesbe heavily managed, lightly managed, or allowed to float freely? Heavilymanaged rates, as described earlier, are subject to the great asymmetry, wherein heavy intervention through foreign exchange sales to maintaina currency above the market-determined level has consistently failed,resulting in much higher foreign debt obligations and more painful ulti-mate adjustment.A lightly managed or free float is clearly preferable atthis end of the asymmetric curve, although painful lessons are still beinglearned in Argentina, Brazil, and Turkey.At the other end of the curve, there is the heavily managed float throughofficial large-scale purchases to maintain an exchange rate lower than themarket-determined level, which usually translates into currency manipu-lation.The case made in this paper is that such heavy management togain an unfair competitive advantage should also be sharply curtailed ifnot eliminated
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