Tariffs, Transshipping, and the Trouble with Vietnam
Many investors were surprised by the level of tariffs announced on April 2 for countries like Vietnam and Taiwan. The conversation since then has largely focused on the trade deficit the US runs with these countries and on the regional influence China exerts. But other concerns about currency manipulation and the role of countries like Vietnam in transshipping may have substantially factored into the US administration’s thinking.
How to Make the Currency Manipulators Monitoring List
In 1988, the US Congress tasked the Secretary of the Treasury to “analyze on an annual basis the exchange rate policies of foreign countries, in consultation with the International Monetary Fund, and consider whether countries manipulate the rate of exchange between their currency and the United States dollar for purposes of preventing effective balance of payments adjustments or gaining unfair competitive advantage in international trade.”
Few countries have ever been deemed outright currency manipulators (South Korea and Taiwan in 1988, Taiwan and China in 1992, China again in 1994 and 2019), but a limited number have consistently appeared on the so-called “monitoring list.” Three criteria must be met for a country to be deemed a currency manipulator.
- Significant bilateral trade surplus with the United States ($15 billion or larger)
- Material current account surplus (3% of GDP or larger)
- Persistent, one-sided currency intervention
Meeting any two of the three places a country on the monitoring list, which in 2024 included China, Japan, Korea, Taiwan, Singapore, Vietnam, and Germany. The third criterion requires “net purchases of foreign currency, conducted repeatedly, in at least 8 out of 12 months, totaling at least 2% of an economy’s GDP.”
The 2.0% of GDP is an exceedingly high threshold and also why almost no country ever meets it — but that doesn’t mean material interventions don’t actually occur. In the November 2024 report, for instance, the US Treasury Department estimated that Japan and Vietnam each intervened to the tune of 1.5% of GDP and Taiwan, 1.4% of GDP.
Sustained material interventions that fall short of 2.0% can still have very powerful cumulative effects, and there is at least circumstantial evidence in the data to that effect. One useful framework for assessing this is the purchasing power parity (PPP) approach. At its core, it’s the idea that exchange rates should adjust over time in a way that equalizes purchasing power across borders.
In practice, such adjustments are inevitably incomplete because arbitrage opportunities are limited to tradable goods and further limited by transaction costs. Nevertheless, while a persistent gap between market and estimated PPP exchange rates could be maintained over time, there is a reasonable expectation that over the long run, under normal circumstances, there should be some degree of convergence between the two.
These are not normal times.
Record Gap Between FX and PPP
Not only are market exchange rates undervalued relative to PPP exchange rate estimates, but that undervaluation is at, or close to, the highest level in 35 years for Korea, Japan, Taiwan, and Vietnam (the latter, by a large margin). Ironically, only in China’s case have conditions been worse in the past — right about the same time the country had been deemed an outright currency manipulator. This is a valid area of concern for the US.
Vietnam’s Growing Role in Global Trade a Factor in Tariffs
Not since China’s rise on the global manufacturing scene has another country made such impressive inroads into the US market as Vietnam. Since the signing of a bilateral trade agreement with the US in 2000, its market share in US imports went from essentially zero to 4.2%, closing in on Japan’s share (Figure 6).
The US bilateral trade deficit with Vietnam was $500 million in 2000; last year, it topped $123 billion. US exports to Vietnam totaled $13 billion last year, against roughly $136 billion in imports.
Beyond currency management, the US has a valid concern about so-called transshipping. This refers to third-party countries using Vietnam (or others) as a production base for exports to the US, to avoid direct US tariffs. Low labor costs make Vietnam attractive as a manufacturing production base in its own right; but given the disproportionate role foreign investment has in driving Vietnamese exports (Figure 7), trans-shipping appears to be a justifiable concern.
Recent Trade Deals Spur Hope for Resolution
The US administration’s tariff policy has caused tremendous market volatility and consternation across trading partners. But the arguably heavy-handed approach shouldn’t obscure the fact that the US has valid grievances it wants to address. As the newly announced trade deal with the UK and active negotiations with China show, we remain hopeful that resolutions allowing for the avoidance of punitive tariffs will be reached. At the same time, we assume those trade agreements would require at least partial redress of the issues highlighted here. If that happens and currently undervalued currencies move closer to fair value or PPP, it implies a weaker US dollar (USD) — making hedging strategies more compelling.
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