Department of the Treasury

Annual Report to Congress on International Economic and Exchange Rate Policy

Period Covered: November 1, 1998 to June 30, 1999

Summary

Major Findings

• The U.S. economy performed strongly over the period November 1, 1998

to June 30, 1999, despite economic weakness in both emerging market

economies and some of the industrial countries. The U.S. economy over

this period continued to experience a combination of strong output growth,

low inflation, and employment expansion not seen in nearly three decades.

• However, amid continuing economic contractions or declining growth

rates across emerging markets, Japanese weakness, and a slowdown in

European growth, U.S. export growth stagnated and the U.S. current

account deficit increased significantly, and it is likely to continue to

increase over the months ahead.

• During the period covered by this report, the relative strength of the

U.S. economy fueled strong capital inflows into the United States. The

increased capital inflows helped sustain domestic investment despite low

personal savings, but also implied a continued deterioration in the U.S. net

international investment position.

• Treasury determined that none of our major trading partners

manipulated exchange rates under the terms of Section 3004 of the Act

during the period under consideration.

Policy Priorities

• Maintain sound economic and financial policies in the United States,

including our strong dollar policy, which is in the interest of the United

States.

• Encourage sound fiscal and monetary policies by our major trading

partners to help ensure an orderly return to more balanced global

growth patterns, and over time contribute to reduced global imbalances.

• Encourage policies that promote strong domestic demand led growth

and low inflation in the G-7 nations, with a particular focus on

macroeconomic stimulus and implementation of banking reforms in

Japan and appropriate macroeconomic policies and structural reforms

in Europe.

• Remain prepared to support temporary financial assistance, led by the

IMF and other IFIs, in support of strong programs to promote recovery

and stability in emerging market economies.

• Put in place agreed measures and policies that will strengthen the

international financial architecture and reduce the risk of future crises.

• Continue efforts to open foreign markets to U.S. exports while resisting

protectionist sentiments everywhere, especially in G-7 nations.

• Continue to monitor the policies and practices of U.S. trading partners

for evidence of currency manipulations.

Table of Contents

Summary 1

Analysis of Currency Market

Developments 2

U.S. Economy 6

U.S. Exchange Rate Policies 9

Emerging Market Exchange

Policies 10

Policy Priorities 12

Appendix 13

This report reviews developments

in U.S. international economic

policy, including exchange rate

policy, during the period from

November 1, 1998 through June

30, 1999. This report is required

under Section 3005 of the Omnibus Trade and Competitiveness

Act of 1988 (“the Act”).

EMBARGOED FOR RELEASE

UNTIL:

4:30 p.m., September 3, 1999

95

96

97

98

99

100

101

102

103

Jan_98

Mar_98

May_98

Jul_98

Sep_98

Nov_98

Jan_99

Mar_99

May_99

Real Value of the Dollar

Federal Reserve Board Staff Real 

Broad Dollar Index, 1973=100
Department of the Treasury

Annual Report to Congress on International Economic and Exchange Rate Policy

Period Covered: November 1, 1998 to June 30, 1999

Page 2

Economic Policy and Currency

Market Developments in Key

Economies

United States

Between November 1998 and June 1999, the Federal Reserve

Board staff’s nominal dollar index indicates that the nominal

value of the dollar appreciated roughly 1.8% on a trade-weighted

basis. This appreciation, which followed a 4% depreciation

between August 1998 and November 1998, likely reflected the

relative strength of the U.S. economy compared to key U.S.

trading partners. Also, U.S. monetary policy was relaxed with a

75 bps. cut in interest rates in the fall in 1998, but then tightened

in June 1999 with a 25 bps. increase. Although during the

period of this report the dollar appreciated relative to the yen, the

euro, and the pound, overall this was partially offset by a

depreciation of the dollar against the Canadian dollar. A

rebound in some emerging market currencies, notably those of

Mexico and Korea, also helped to temper the overall

appreciation of the dollar. Between November 1998 and June

1999, the Federal Reserve staff’s real effective dollar exchange

rate appreciated by roughly 1%.

Euroland

On January 1, 1999, the currencies of the eleven countries that

compose the European Monetary Union were irrevocably fixed

based on the central parities of the European Monetary System

and the value of the new common currency, the euro, was set

equal to the value of the ECU on December 31, 1998. Euro

notes and coins will begin to replace the separate national

currencies on January 1, 2002. Between January 1999 and June

1999, the dollar appreciated 12.7% against the euro. The real

effective value of the euro depreciated roughly 5% between

January 1999 and May 1999. Market participants attribute the

decline to weaker Euroland growth compared to the United

States. In response to slowing growth in Euroland, the European

Central Bank cut the benchmark interest rate, the repo rate, by

50 bps. to 2.5% in March 1999, following a coordinated interest

rate cut by member countries led by the Bundesbank’s 30 bps.

cut in December 1998. The June Consensus forecast anticipates

2.0% growth in the Euroland countries in 1999, compared to

2.7% growth in 1998. European countries need to pursue

appropriate macroeconomic policies and structural reforms to

promote strong domestic demand led growth.

United Kingdom

During the period covered by this report, the dollar appreciated

4.1% against the pound in response to slowing growth and

falling interest rates in the United Kingdom, although both

currencies appreciated against the euro. First quarter 1999 real

GDP in the United Kingdom was flat following a small 0.3%

increase in the final quarter of 1998. In response to the slowing

domestic economy, the Bank of England initiated a series of

interest rate cuts on October 8, 1998 that has so far resulted in

total cuts of 200 bps. Interest rates in the UK remain roughly

250 bps. higher than interest rates in Euroland.

Japan

After a sharp rise in the value of the yen against the dollar in the

fall of 1998, between November 1998 and January 1999, the yen

appreciated a further 5.8% from 120.3¥/$ to 113.3¥/$. In

February 1999 the trend reversed and the dollar began to

appreciate against the yen following additional monetary easing

0.80

0.85

0.90

0.95

1.00

Jan_98 Apr_98 Jul_98 Oct_98 Jan_99 Apr_99

Currency Movements: Euroland

Euros per Dollar

Note: European Currency Units prior to January 1, 1999

0.55

0.60

0.65

Jan_98 Apr_98 Jul_98 Oct_98 Jan_99 Apr_99

Currency Movements: United Kingdom

Pounds per Dollar 110

112

114

116

118

120

122

Jan_98 Apr_98 Jul_98 Oct_98 Jan_99 Apr_99

Currency Movements: United States

Federal Reserve Board N ominal Broad Dollar Index, 1997=100
Department of the Treasury

Annual Report to Congress on International Economic and Exchange Rate Policy

Period Covered: November 1, 1998 to June 30, 1999

Page 3

by the Bank of Japan, which acted on February 12, 1999 to push

overnight interest rates to near-zero levels. Upward pressure on

the yen emerged in June 1999 when it was announced that

Japan’s economy recorded an annualized 7.9% growth rate in

the 1st quarter of 1999, following five consecutive quarters of

negative real GDP growth. This rise in output largely reflected

the impact of fiscal stimulus measures enacted in 1998, although

growth was recorded in all components of domestic demand. In

the days following the release of the GDP data on June 10, 1999,

the Japanese monetary authorities intervened in the currency

markets – purchasing substantial amounts of dollars and euros –

to prevent an appreciation of the yen. Neither U.S. nor

European monetary authorities participated in the Japanese intervention, although the European Central Bank acted as the Bank

of Japan’s agent in the European markets. Despite the strong 1st

quarter GDP numbers, private demand remains weak, making it

critically important that Japan maintain macroeconomic stimulus

until sustainable, domestic demand led growth is restored.

Furthermore, although Japan has taken important steps in

addressing its banking sector problems, more aggressive steps to

accelerate the permanent disposal of bad assets are needed.

Canada

During the period covered by this report, the dollar depreciated

by 4.6% against the Canadian dollar. Market participants

attributed the rise in the Canadian dollar largely to two factors.

First, growth prospects for Canada improved. Second, commodity prices stopped falling at the end of 1998, and with some

such as oil prices, rising. Because Canada exports a significant

amount of commodities, an improved outlook for commodity

prices boosts the demand for Canadian dollars.

Brazil

Brazil came under acute financial pressure in the second half of

1998 as markets focused on its fixed (sliding band) exchange

rate and wide fiscal deficit. In November 1998, Brazil reached

agreement with the IMF on an economic program with fiscal adjustment at its core, which the international community agreed to

support with a $41.5 billion package: $18 billion from the IMF,

$9 billion from the IDB and World Bank, a $13.28 billion from a

BIS lending facility for Brazil, most of which was guaranteed by

a number of countries, including the United States, and a parallel

$1.25 billion lending facility from the Bank of Japan.

Following the agreement with the IMF and announcement of

international support, Brazil’s financial situation improved, and

the pace of foreign reserve loss slowed significantly. However,

investor confidence deteriorated in December, and reserve

outflows accelerated again. Doubts about the capacity to

implement fiscal adjustment intensified in January 1999, in part

due to actions by some Brazilian states. By mid-January, net

international reserves had fallen to $30 billion, compared to $70

billion only 6 months earlier, and the Brazilian authorities first

decided to devalue the real and, later, they allowed it to float.

Within two months of the decision to float the real, it

depreciated 44%, to a low of 2.15R/$ on March 3, 1999. In

March, Brazil named a new team at the central bank, reached

agreement with the IMF on a revised program, passed key fiscal

measures, and secured the commitment of major foreign creditor

banks to maintain their short-term exposure to Brazil. Those

developments, plus evidence that domestic inflation pressures

remained relatively subdued, helped to restore confidence. Capital outflows began to reverse and the real appreciated significantly. At the end of June, the real was 1.75R/$, 31% depreciated from its pre-devaluation level but up 23% from its low

point of early March. The IMF projects that GDP will contract

by about 1% this year, with about 8% consumer price inflation, a

significantly more favorable outcome than anticipated earlier.

Unlike the crisis in some Asian countries, Brazil’s economic

crisis resulted primarily from public sector rather than private

sector imbalances. Brazil’s large fiscal deficits amounted to 7%

and 8% of GDP in 1997 and 1998, respectively. Financial sector

and corporate governance problems were not major contributors

to the economic crisis, and therefore did not figure prominently

in Brazil’s IMF program.

0.90

1.10

1.30

1.50

1.70

1.90

2.10

Jan_98 Apr_98 Jul_98 Oct_98 Jan_99 Apr_99

Currency Movements: Brazil

Reais per Dollar (Inverted Scale)

1.30

1.35

1.40

1.45

1.50

1.55

1.60

Jan_98 Apr_98 Jul_98 Oct_98 Jan_99 Apr_99

Currency Movements: Canada

Canadian Dollars per Dollar

100

110

120

130

140

150

160

Jan_98 Apr_98 Jul_98 Oct_98 Jan_99 Apr_99

Currency Movements: Japan

Yen per Dollar
Department of the Treasury

Annual Report to Congress on International Economic and Exchange Rate Policy

Period Covered: November 1, 1998 to June 30, 1999

Page 4

Other Latin American Countries

In the second half of 1998, global investors focused on potential

policy vulnerabilities in Latin American countries, which, along

with emerging market financial strains in general, led to tighter

credit conditions. Political uncertainty also contributed to the

economic slowdowns in some countries.

• Mexico. Last fall, economic growth in Mexico slowed

in response to a sharp hike in domestic interest rates to

contain inflation pressures stemming from peso

depreciation. The situation was further aggravated by

low oil prices, which led the government to make fiscal

cuts in order to meet its fiscal deficit targets. But strong

economic momentum from the first half of 1998 and the

strong economy in the United States helped Mexico to

achieve a 4.8% growth rate for 1998 despite the

slowdown – a higher growth rate than any of the other

major economies in Latin America. By June 1999, the

value of the peso had appreciated by 6.1% from January

1999, supported by an improved economic outlook,

thanks in part to calmer global markets and a rise in

world oil prices.

• Venezuela. During the period of this report, Venezuela

experienced widening fiscal deficits (due in part to low

oil prices) and political uncertainties (associated with the

election of President Hugo Chavez in December 1998),

as well as the effects of global financial turbulence. It

responded to the resulting financial pressures by sharply

raising domestic interest rates last fall. The high interest

rates and low oil prices – oil accounts for about 70% of

Venezuelan exports – contributed to recession and a rise

in unemployment this year. Although economic activity

showed few signs of recovery in the first half of 1999,

the easing of global financial pressures and the sharp

rebound in oil prices in the past few months have helped

interest rates to fall back to previous levels and improved

the fiscal outlook.

• Argentina. Argentina was also affected by global

financial turbulence, which restricted its access to international capital markets, by low commodity prices, and

by a weakening of exports to Brazil, a key trading

partner. Those factors contributed to a sharp economic

slowdown, from 4.2% growth in 1998 to an anticipated

1.5% contraction expected by the IMF and the Argentine

government for 1999, before recovery in 2000. During

this period Argentina remained committed to its

currency board arrangement. The Argentine government

announced that it would consider full dollarization of its

economy.

• Ecuador. Ecuador was the Latin American country in

most dire economic circumstance in the first half of

1999, largely due to low oil prices, the El Nino weather

phenomenon, and reduced access to international capital

markets. These conditions were aggravated by serious

solvency problems in much of the banking sector, its

high levels of foreign and domestic debt, chronic fiscal

deficits, and questions about the ability of the government to deliver a strong policy response. In February,

Ecuador allowed its currency, the sucre, to float.

Following a sharp depreciation, the sucre temporarily

rebounded, supported by a freeze on bank deposits.

Ecuador is at present discussing a stand-by arrangement

with the IMF.

• Colombia. The Pastrana administration (elected in May

1999) responded to oil price and global capital market

shocks and to the widening fiscal deficits it inherited by

raising interest rates and enacting fiscal cuts. As the

economy slowed, the levels of nonperforming loans in

the banking system rose. Slow progress in the peace

talks with leftist guerillas added to the concerns of

foreign investors, and pressure on the exchange rate led

Colombia to devalue its currency in June 1999. Looking

forward, Colombia’s main economic challenges include

resuming economic growth and restoring the health of

the banking system. Columbia is currently discussing a

program that could receive the IMF’s financial support.

Real GDP Growth: Selected Latin American Countries

% change over a year ago

Mexico Brazil Venezuela Argentina

Q1_98 6.4 1.2 9.7 6.4

Q2_98 5.6 1.4 1.7 6.7

Q3_98 4.8 -0.2 -4.5 3.3

Q4_98 2.6 -1.9 -8.2 -0.6

Q1_99 1.9 -0.8 -- -3.0

Source: Haver Database

Currency Values: Selected Latin American Countries

Domestic currency units per Dollar

Nov98 Jun99 Change

Mexico (Pesos/$) 9.97 9.51 -4.6%

Venezuela (Bolivares/$) 569.1 602.6 5.9%

Ecuador (Sucres/$)) 6449.4 10854.1 68.3%

Colombia (Pesos/$) 1562.2 1695.4 8.5%

90

110

130

150

170

190

210

230

250

270

Jan_98 Apr_98 Jul_98 Oct_98 Jan_99 Apr_99

Mexico

Venezuela

Ecuador

Colombia

Currency Movements: Selected Latin American Countries

Domestic Currency Units per Dollar, Jan. 1998=100 (Inverted Scale)
Department of the Treasury

Annual Report to Congress on International Economic and Exchange Rate Policy

Period Covered: November 1, 1998 to June 30, 1999

Page 5

Emerging Asia

The economic and financial situation in Asia improved markedly

during the period covered by this report. Continued progress in

implementing economic reforms aided in bolstering investor

confidence while stimulative macroeconomic policies made

possible by recovering confidence throughout the region also

helped to restore growth in the countries most affected by the

crisis.

• The stabilization of exchange rates and falling inflation

in the region enabled central banks to continue to lower

interest rates during the reporting period. Interest rates

fell most dramatically in Indonesia, declining from 56%

in October 1998 to 19% in June 1999.

• Growth bounced back most strongly in Korea, and the

Consensus forecast now predicts a 5.1% rise in real GDP

in 1999 after a 5.8% contraction last year. Malaysia, the

Philippines, and Thailand are also expected to return to

positive growth this year, while growth in Singapore is

forecast to strengthen significantly. Growth in China is

forecast by the government to slow from 7.8% in 1998 to

7.0% in 1999, while growth in Taiwan is expected to

hold steady at 4.8% in 1999. Based on June 1999

Consensus forecasts, only Hong Kong and Indonesia are

expected to remain in recession during 1999, although

the contraction in both economies is predicted to be far

smaller than in 1998.

• Most countries in Asia are expected to record smaller

current account surpluses in 1999, compared to 1998, as

imports have begun to rebound from their extraordinarily

weak levels of last year. Stronger regional growth,

continued robust growth in the United States, and an

upturn in electronics demand are also contributing to an

improved outlook for exports.

Exchange rates in the region have stabilized, and both the

Korean won and Indonesian rupiah have strengthened

substantially. Equity markets in Asia rose sharply as a result of

the improved economic and financial outlook. Nevertheless,

there is little room for complacency in the region given the

extent of bank and corporate restructuring and other challenges

that remain to be tackled.

• Although there has been significant progress in bank

recapitalization and restructuring, this is a complex and

difficult challenge that will take considerable time to

resolve. The process of corporate restructuring and

restoring health to corporate balance sheets is only now

beginning in these countries.

• The external environment also presents some potential

risks to recovery. Stronger domestic growth in Japan

and Europe would help provide support for exports for

the region, as well as further strengthen commodity

prices.

China faces significant challenges in maintaining economic

growth and pushing forward key structural reforms. The

government has substantially increased public investment and

has relaxed monetary policy, but growth is slowing and

deflationary pressures seem to be spreading. The Government

of China has made reform of its troubled financial sector a

priority, but efforts are still at an early stage. Concerns about

contributing to rising unemployment has kept reform of China’s

state owned enterprises on a cautious path.

100

1000

Jan_97 Jul_97 Jan_98 Jul_98 Jan_99

Korea

Taiwan

Hong Kong

Singapore

Currency Movements: NIEs

Domestic currency units per dollar, Jan. 1997 = 100

Logarithmic scale, inverted scale

200

500

100

1000

Jan_97 Jul_97 Jan_98 Jul_98 Jan_99

Indonesia

Malaysia

Phillipines

Thailand

Currency Movements: Selected ASEAN Countries

Domestic currency units per dollar, Jan. 1997 = 100

Logarithmic scale, inverted scale

200

500
Department of the Treasury

Annual Report to Congress on International Economic and Exchange Rate Policy

Period Covered: November 1, 1998 to June 30, 1999

Page 6

U.S. Economy

Overview of the U.S. Economy

With a combination of strong growth and low inflation, the

U.S. economic expansion continued during the period

covered by this report (November 1, 1998 to June 30, 1999).

U.S. GDP expanded 6.0%, 4.3%, and 2.3% in the 4th quarter of

1998 and the 1st and 2nd quarters of 1999, respectively, compared

to 3.9% growth for 1998 as a whole. The consistent growth in

real U.S. output contributed to a fall in the unemployment rate

from 4.5% in October 1998 to 4.3% in June 1999. CPI inflation

(year over year) remained low but increased slightly, edging up

from 1.5% in October 1998 to 2.1% in May 1999. The strength

of consumer spending as a driving force in the economy was

illustrated by the steady decline of the recorded personal savings

rate from –0.2% in October 1998 to –1.0% in June 1999,

although national savings has risen as a result of the government

budget surplus (see chart on page 8).

External events continued to have a significant impact on the

U.S. economy. Strong domestic growth and economic weakness

abroad contributed to a widening goods and services deficit,

which in turn eased some domestic demand pressures.

IMF Article IV Consultation

The conduct of economic policy by the U.S. Administration

and the Federal Reserve was praised by the IMF staff in the

conclusion of the IMF staff’s 1999 consultation with the

United States on June 17, 1999 (in accordance with Article

IV of the IMF’s Articles of Agreement). The IMF staff said

that “[t]he U.S. authorities are to be highly commended for their

sound fiscal and monetary policies, which have contributed

significantly to what is now approaching the longest economic

expansion in U.S. history.”

The IMF staff noted that the United States is the principal engine

of global growth during the recent period of global financial

turbulence and that “U.S. monetary policy played a key role in

stabilizing international financial markets.” The staff also noted

that “[o]ver the past year and a half, the appreciation of the U.S.

dollar has shifted demand abroad, helping to avert overheating in

the United States and mitigating the adverse effects of the global

economic turbulence.” The IMF staff, however, cautioned that

the orderly return of more balanced global demand growth

patterns would be a policy challenge for both the United States

and its trading partners. Consistent with a broad effort by the

United States to enhance the transparency of the IMF, the United

States is part of a pilot program recently established by the

IMF’s Executive Board to allow countries to release the staff

reports on their Article IV reviews. The staff report is expected

to be publicly released in August 1999.

0

1

2

3

Jan_98 Apr_98 Jul_98 Oct_98 Jan_99 Apr_99

U.S. Consumer Price Inflation

% change over a year ago

Source: Bureau of Labor Statistics

4.0

4.2

4.4

4.6

4.8

Jan_98 Apr_98 Jul_98 Oct_98 Jan_99 Apr_99

U.S. Civilan Unemployment Rate

%

Source: Bureau of Labor Statistics

-2

-1

0

1

Jan_98 Apr_98 Jul_98 Oct_98 Jan_99 Apr_99

U.S. Personal Savings Rate 

% of disposable personal income (SAAR)

Source: Bureau of Economic Analysis

0

2

4

6

Q1_98 Q2_98 Q3_98 Q4_98 Q1_99 Q2_99

U.S. Real Gross Domestic Product

% change over previous quarter, annual rate

Source: Bureau of Economic Analysis
Department of the Treasury

Annual Report to Congress on International Economic and Exchange Rate Policy

Period Covered: November 1, 1998 to June 30, 1999

Page 7

Trade Flows

The strength of the U.S. economy, combined with weakness

abroad, generated significant expansions of both the trade

and current account deficits during the period covered by

this report, despite a surge of exports in the 4th quarter of

1999. The current account deficit rose from $254 billion SAAR

(seasonally adjusted annual rate) in the 3rd quarter of 1998 to

$274 billion SAAR in the 1st quarter of 1999. During this same

period, the goods and services trade deficit increased from $183

billion SAAR to $215 billion SAAR, while the April-May 1999

deficit was $239 billion SAAR. The current account deficit

reached $221 billion, 2.6% of GDP, in 1998, a record in absolute

terms but, as a percentage of GDP, significantly less than the

3.5% of GDP deficit recorded in 1987.

• The primary factor underlying the sharp rise in the

current account deficit in 1998 was the overall fall in

U.S. exports. Goods exports to emerging Asia fell

$20.6 billion, while exports to Japan fell $7.6 billion.

Nominal U.S. exports actually fell 0.5% in 1998, the first yearover-year drop in exports since 1985, compared to the 10.4%

growth experienced in 1998. This was attributable to severe

economic weakness abroad, particularly in Asia, that decreased

the foreign demand for U.S. goods and services. In contrast,

strong economic growth in the United States generated sustained

growth in nominal imports, although the 5.3% growth in

U.S. Trade in Goods and Services

$ Billion (Balance of Payments Basis)

Exports Imports

Level Change Level Change

1993 641.8 4.2% 711.7 9.0%

1994 702.1 9.4% 800.5 12.5%

1995 793.5 13.0% 891.0 11.3%

1996 849.8 7.1% 954.1 7.1%

1997 938.5 10.4% 1,043.3 9.3%

1998 933.9 -0.5% 1,098.2 5.3%

Source: Bureau of Economic Analysis, Bureau of the Census

U.S. Bilateral Merchandise Trade Balances

$ Billion, nsa

Mexico Canada Japan China EU

Q4_97 -2.9 -3.9 -15.4 -13.1 -5.6

Q1_98 -2.7 -3.0 -15.3 -11.5 -2.1

Q2_98 -4.5 -3.3 -15.6 -13.6 -7.0

Q3_98 -4.4 -5.3 -15.5 -17.3 -8.6

Q4_98 -4.2 -5.1 -17.6 -14.5 -9.7

Q1_99 -6.0 -6.9 -16.4 -13.6 -5.8

Note: Non-seasonally adjusted (nsa) bilateral trade data can be volatile from

quarter to quarter.

Source: Bureau of Economic Analysis, Bureau of the Census

nominal imports in 1998 was well below the 1997 growth rate of

9.3%. While the growth in nominal imports was muted by

falling import prices and an appreciating dollar, the 1998 growth

in real imports of 10.6% (national income product accounts

(NIPA) basis) was also less then the 1997 rate of 13.9% (NIPA

basis).

The rise in the overall U.S. goods and services deficit was

reflected in rising bilateral merchandise trade deficits with U.S.

trading partners, particularly those in Asia and Europe. The

trade deficit with Japan of $64 billion in 1998, compared to

$56.1 billion in 1997, was the largest U.S. bilateral trade deficit.

The second largest bilateral deficit was the $56.9 billion 1998

deficit with China, up from $49.7 billion in 1997. Other sizeable

bilateral deficits were recorded with the European Union ($27.3

billion in 1998, up from $16.8 billion in 1997), Canada ($16.7

billion in 1998, up from $16.4 billion in 1997), and Mexico

($15.9 billion in 1998, up from $14.5 billion in 1997).

200

220

240

260

280

300

Q4_97 Q1_98 Q2_98 Q3_98 Q4_98 Q1_99

Exports Imports

U.S. Trade in Goods and Services

$ Billion (Balance of Payments Basis)

Source: Bureau of Economic Analysis, Bureau of the Census

5

10

15

Sep_97 Dec_97 Mar_98 Jun_98 Sep_98 Dec_98 Mar_99

Exports Imports

Source: Bureau of Economic Analysis, Bureau of the Census 

U.S. Merchandise Trade with Emerging Asia

$ Billion, nsa

-300

-250

-200

-150

-100

-50

0

Q4_97 Q1_98 Q2_98 Q3_98 Q4_98 Q1_99

Current Account

Goods and Services Account

U.S. External Balances

$ Billion, SAAR (Balance of Payments Basis)

Source: Bureau of Economic Analysis, Bureau of the Census
Department of the Treasury

Annual Report to Congress on International Economic and Exchange Rate Policy

Period Covered: November 1, 1998 to June 30, 1999

Page 8

Capital Flows into the United States

$ Billion, sa, details might not equal totals due to rounding

Q4_97 Q1_98 Q2_98 Q3_98 Q4_98 Q1_99

Net Capital Flows............................................... 113 38 44 33 102 80

Net Portfolio Flows............................................. 44 98 60 -14 -31 78

U.S. acquisition of foreign assets*.......................... -57 -21 -47 -5 -55 8

Foreign acquisition of U.S. assets........................... 101 119 107 -9 50 70

Foreign Official.............................................. -26 11 -11 -46 24 9

Private**...................................................... 127 108 118 38 27 62

Net Banking Flows............................................. 66 -50 6 44 15 21

Assets........................................................... -25 -1 -28 -33 37 35

Liabilities....................................................... 91 -49 34 77 -22 -15

Net Direct Investment.......................................... 3 -10 -22 3 90 -19

U.S. Direct Investment Abroad.............................. -30 -37 -43 -22 -31 -38

Foreign Direct Investment in the United States........... 34 27 21 25 121 19

Source: Bureau of Economic Analysis

* Net private claims on foreigners by nonbanks plus net private U.S. purchases of foreign securities.

** Net purchases of U.S. Treasury securities, net nonbank liabilities to foreigners, net purchases of govt. non-Treasury securities, and net U.S. currency flows.

Capital Flows

Capital inflows remained strong during the period covered

by this report, supporting high levels of business investment

in the United States. Capital inflows help maintain lower

interest rates than would likely be possible otherwise. Increased

capital flows and trade deficits, however, increase the potential

vulnerability to changes in global financial markets’ perceptions

of investment opportunities in the United States.

As global demand patterns revert towards historical trends,

the United States will likely experience a moderation in the

pace of capital inflows and a related adjustment in the

current account. It is important that sound domestic policies be

in place in both the United States and our major trading partners

to help prevent a disruptive adjustment. In this light, policies in

our major trading partners that encourage domestic growth and

investment and policies in the United States that support national

savings are important to contain the rise in imbalances and

facilitate their eventual reduction.

The stock of U.S. assets owned by foreigners is increasing.

The value of foreign investment in the United States already

exceeds the value of U.S. investments in other countries. The

U.S. net international investment position (NIIP) at year end

1998 was negative $1,239 billion with direct investment valued

at the current cost of replacing plant, equipment and other

tangible assets, compared to negative $968 billion at year end

1997. With direct investment valued at the current stock market

value of owner’s equity, the U.S. NIIP at year end 1998 and

1997 was negative $1,538 billion and negative $1,066 billion,

respectively. The larger increase on this basis primarily reflects

the continued large increases in U.S. equity prices. A growing

negative U.S. NIIP implies that a larger amount of the return

generated by assets in the United States will be payable to

foreigners in the future. It is vital that current high level of

business investment is employed productively to support both

future repayments to foreigner investors and increased standards

of living in the United States.

-1800

-1500

-1200

-900

-600

-300

0

1992 1993 1994 1995 1996 1997 1998

Current Cost

Market Value

U.S. Net International Invetment Position

$ Billion

Source: Bureau of Economic Analysis

1,300

1,400

1,500

1,600

1,700

Q1_97Q2_97Q3_97Q4_97Q1_98Q2_98Q3_98Q4_98Q1_99

Gross Savings

Gross Domestic Investment

U.S. National Savings and Investment

$ Billion, SAAR

Source: Bureau of Economic Analysis
Department of the Treasury

Annual Report to Congress on International Economic and Exchange Rate Policy

Period Covered: November 1, 1998 to June 30, 1999

Page 9

U.S. Exchange Rate Policies

G-7 Statements on Exchange Rate Policies

During the reporting period, November 1, 1998 to June 30,

1999, G-7 Finance Ministers and Central Bank Governors

reaffirmed their standing commitment to reduce imbalances and

cooperate closely in the exchange rate markets.

• February 20, 1999. “In view of the increasing integration of the world economy and financial system we have

a special responsibility with regard to improving the

conditions for a proper functioning of the international

financial and monetary system and, in particular,

enhancing sound fundamentals necessary for exchange

rate stability. To this end, we will maintain strong

cooperation to promote stability of the international

monetary system and to promote exchange rates among

major currencies that are in line with fundamentals. We

discussed developments in our exchange and financial

markets since our last meeting. We reaffirmed our view

on the importance of pursuing policies to help avoid

excess volatility and significant misalignments of

exchange rates of major currencies. We will continue to

monitor developments in exchange markets and

cooperate as appropriate.”

• April 26, 1999. “We reaffirmed our view on the

importance of pursuing policies to promote sound

economic fundamentals and more balanced growth

among key economies and thereby help avoid excess

volatility and significant misalignments of exchange

rates of major economies. We will continue to monitor

developments in exchange markets and cooperate as

appropriate.”

Statement by Secretary Summers

Secretary Summers reaffirmed the principles of U.S exchange

rate policies:

• July 26, 1999. “As I have said many times, a strong

dollar is very much in the interest of the U.S. That has

been our policy, it will continue to be our policy. It is a

policy that has served the U.S. well in promoting

confidence, in reducing inflation, in reducing capital

costs for American firms, in promoting capacity-creating

investment."

Currency Intervention

U.S. monetary authorities did not engage in any intervention for

their own account during the period covered by this report.
Department of the Treasury

Annual Report to Congress on International Economic and Exchange Rate Policy

Period Covered: November 1, 1998 to June 30, 1999

Page 10

Emerging Market Exchange

Rate Regimes

Elements of Manipulation

Section 3004 of the Omnibus Trade and Competitiveness Act of

1988 requires the Treasury to analyze annually the exchange rate

policies of foreign countries, in consultation with the IMF, and

to consider whether countries manipulate the rate of exchange

between their currency and the dollar for purposes of preventing

effective balance of payments adjustments or gaining unfair

comparative advantage in international trade. The Secretary of

the Treasury is required to undertake negotiations with those

manipulating countries that have material global current account

surpluses and significant bilateral trade surpluses with the

United States, unless there would be a serious detrimental

impact on vital national economic and security interests.

• Treasury undertook a broad review of the performance of major trading partners of the United Stated

and concluded that none of them has manipulated

their exchange rate under the terms of Section 3004

during the period examined. While several countries

in Asia developed large external surpluses in the wake of

the regional financial crisis, these surpluses were a

consequence of the collapse of domestic demand and

investor confidence, not the result of currency manipulation.

In evaluating evidence of currency manipulation, Treasury looks

at the following five factors:

• External Balances. Persistent global current account

surpluses are fundamentally a reflection of an excess of

national savings over national investment, but in some

cases may also reflect efforts to maintain an exchange

rate level that would prevent external adjustment.

• Exchange Restrictions and Capital Controls. Restrictive exchange regimes and capital controls can be a

concern, particularly where the restrictions are designed

to maintain an consistently undervalued exchange rate.

• Exchange Rate Movements. Large depreciations of

exchange rates, if induced artificially rather than by

market forces responding to fundamentals, could suggest

an attempt to gain a comparative advantage in trade.

Manipulation could also be reflected in the absence of a

significant appreciation of the exchange rate when

justified by fundamentals. Equilibrium real exchange

rates, however, are determined by a number of factors

and are therefore difficult to define.

• Movements in Reserves. Significant and persistent

accumulation of foreign exchange reserves could be a

source of concern if it reflects efforts to maintain an

excessively competitive exchange rate.

• Macroeconomic Trends. When analyzing these

economies, Treasury looks at the macroeconomic policy

stance and other conditions that are important determinants of exchange rates.

Country Assessments

As the law requires, economies were closely examined as

potential exchange rate manipulators if they had significant

global current account surpluses and bilateral surpluses with the

United States and maintained a fixed or actively managed

exchange rate system during the period of this report. The

following countries met these criteria.

• Singapore. Singapore’s current account surplus is

estimated to have increased to 19.6% of GDP in 1998

from 15.4% in 1997, due largely to a drop in imports as

GDP growth slowed to 1.5% in 1998, the lowest growth

rate in more than a decade. The June Consensus forecast

predicts a recovery in growth to 2.5% this year and,

consequently, the current account surplus is projected to

decrease to 18% of GDP in 1999 as domestic imports

recover. Since November 1998, the Singaporean dollar

has depreciated 5% against the U.S. dollar and 1% in

real-effective terms. The relatively small decline in the

Singaporean dollar appears to reflect the relaxation of

monetary policy and the relative weakness of the

economy. Singapore’s reserves have increased by less

than 2% during the period covered by this report.

• China. During the reporting period, China continued to

fix the renminbi to the dollar at 8.28 RMB/$. The real

effective exchange rate was stable but has depreciated

roughly 9% since December 1997 as regional exchange

rates appreciated since the peak of the crisis. In 1998,

China's current account surplus fell slightly to $29

billion (3% of GDP, compared to 3.2% in 1997) and is

expected to be significantly smaller in 1999 as China’s

trade surplus declines. For the first five months of 1999

the trade surplus fell 62 percent to $7.1 billion compared

to the same period in 1998, as exports dropped 5 percent

due to weak demand in Asia. Also, official imports

surged 15 percent, partially in response to a crackdown

on smuggling which reportedly resulted in greater

accuracy in the recording of imports. The government

tightened foreign exchange controls in September 1998

in an effort to reduce smuggling and capital flight. In

June 1999, the PRC restricted RMB transactions outside

of China's borders in a further effort to maintain strict

control of the exchange rate. Despite these restrictions
Department of the Treasury

Annual Report to Congress on International Economic and Exchange Rate Policy

Period Covered: November 1, 1998 to June 30, 1999

Page 11

reserves grew only $6 billion in 1998 and grew less than

$2 billion during the first five months of 1999.

• Malaysia. The Malaysian economy suffered its worst

recession in more than a decade last year, with GDP

contracting by 7.5%. The government is currently

projecting 1% growth for this year. The current account

swung from a deficit of 5% of GDP in 1997 to a surplus

of 13% of GDP in 1998 as import demand contracted

sharply, but is forecast to decrease to a surplus of 11% of

GDP in 1999 as the economy begins to recover.

Malaysia’s exports have benefited recently from the

depreciated value of the ringgit, which was pegged at

RM3.8/$1 in September 1998. Although this rate was

10% higher than the market rate at the time the exchange

rate was pegged, most other regional currencies have

appreciated since then. The real effective value of the

ringgit remains 26% weaker than its pre-crisis level.

Between October 31, 1998 and May 31, 1999,

Malaysia’s reserves increased by $6.3 billion, or 27%, to

$30 billion. The government has relaxed the scope of

the capital controls imposed last fall, but has not

provided any indication as to when they will be

abolished.

• Taiwan. During the period covered by this report, the

New Taiwan Dollar (NTD) has moved little against the

U.S. dollar, but has appreciated by roughly 9% on a real

effective basis (due to deflation in China and Hong

Kong). Since January 1998, Taiwan’s central bank has

intervened at times in an effort to maintain the currency

in a narrow range around 32.5NTD/$. Taiwan

weathered the Asian crisis fairly well, with 4.8% growth

in real GDP in 1998, and the government projects

growth of 5.1% this year. Taiwan’s current account

balance in 1998 declined to a surplus of $3.7 billion

(1.4% of GDP), compared to $7.7 billion in 1997.

Foreign exchange reserves increased by $11.1 billion, or

13%, over the reporting period, reaching $97.7 billion in

June 1999.

• Korea. The won appreciated by 14% against the dollar

between November 1998 and June 1999. The contraction

in domestic demand in 1998, combined with a

substantially depreciated won (compared to pre-crisis

levels) led to a sharp increase in the current account

surplus in 1998 ($40.5 billion, or more than 13% of

GDP). After declining by 5.8% in 1998, the Korean

economy is recovering with GDP expected to grow by 4-

5% this year. The strengthening of the won and

recovering import demand are resulting in a considerably

smaller current account surplus this year. During the first

four months of 1999 the current account surplus has fallen

nearly 40% compared to the same period in 1998; over

the same time period Korea’s bilateral trade surplus with

the U.S. has fallen by about 31%. Korea’s useable

reserve position improved substantially during 1998,

reaching approximately $55 billion at the end of the year

compared to $9.1 billion at the end of 1997. Korea has

continued to accumulate foreign exchange reserves, as a

result of its current account surplus and capital inflows,

with reserves totaling about $60 billion at the end of June

1999.
Department of the Treasury

Annual Report to Congress on International Economic and Exchange Rate Policy

Period Covered: November 1, 1998 to June 30, 1999

Page 12

Policy Priorities

The most important policies in responding to the present

challenges include the following objectives:

• Maintain sound economic and financial policies in the

United States, including our strong dollar policy, which

is in the interest of the United States.

• Maintain sound domestic policies to offset the impact

of the rising current account deficit. An adjustment of

the U.S. external imbalance would be eased by policies

designed to raise the level of national savings. Maintaining a budget surplus is essential to this goal.

• Policies that promote sustained, domestic demand led

growth in our major industrial trading partners. It is

important that the Japanese authorities follow through on

their recent efforts to restore economic growth in Japan

and that European countries pursue strong growth

policies, including structural reforms.

• Providing financial assistance for strong economic

programs, anchored with IMF support, designed to

promote recovery and stability in emerging market

economies.

• Put in place agreed measures and policies to

strengthen the international financial architecture and

reduce the risk of future crises. G-7 leaders have

endorsed steps to help prevent financial crises and better

respond to them when they occur. These measures are

designed to strengthen the international financial

institutions, enhance transparency, strengthen regulation

in lending countries, equip emerging market economies to

deal better with risk, share responsibility for resolving

crises with the private sector, and protect the vulnerable in

society, particularly in the face of crises.

• Continue efforts to open foreign markets to U.S.

exports while resisting protectionist sentiment.

• Treasury will continue monitoring the markets for

evidence of currency manipulation.
Department of the Treasury

Annual Report to Congress on International Economic and Exchange Rate Policy

Period Covered: November 1, 1998 to June 30, 1999

Page 13

Appendix

OMNIBUS TRADE AND COMPETITIVENESS

ACT OF 1988 (H.R. 3)

SEC. 3004. INTERNATIONAL NEGOTIATIONS ON

EXCHANGE RATE AND ECONOMIC POLICIES.

(a) Multilateral Negotiations.-The President shall seek to confer

and negotiate with other countries-

(1) to achieve-

(A) better coordination of macroeconomic policies of

the major industrialized nations; and

(B) more appropriate and sustainable levels of trade

and current account balances, and exchange rates

of the dollar and other currencies consistent with

such balances; and

(2) to develop a program for improving existing

mechanisms for coordination and improving the

functioning of the exchange rate system to provide for

long-term exchange rate stability consistent with more

appropriate and sustainable current account balances.

(b) Bilateral Negotiations.-The Secretary of the Treasury shall

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. If

the Secretary considers that such manipulation is occurring with

respect to countries that (1) have material global current account

surpluses; and (2) have significant bilateral trade surpluses with

the United States, the Secretary of the Treasury shall take action

to initiate negotiations with such foreign countries on an

expedited basis, in the International Monetary Fund or

bilaterally, for the purpose of ensuring that such countries

regularly and promptly adjust the rate of exchange between their

currencies and the United States dollar to permit effective

balance of payments adjustments and to eliminate the unfair

advantage. The Secretary shall not be required to initiate

negotiations in cases where such negotiations would have a

serious detrimental impact on vital national economic and

security interests; in such cases, the Secretary shall inform the

chairman and the ranking minority member of the Committee on

Banking, Housing, and Urban Affairs of the Senate and of the

Committee on Banking, Finance and Urban Affairs of

Representatives of his determination.

SEC.3005. REPORTING REQUIREMENTS.

(a) Reports Required.-In furtherance of the purpose of this title,

the Secretary, after consultation with the Chairman of the Board,

shall submit to the Committee on Banking, Finance and Urban

Affairs of the House of Representatives and the Committee on

Banking, Housing, and Urban Affairs of the Senate, on or

before October 15 each year, a written report on international

economic policy, including exchange rate policy. The Secretary

shall provide a written update of developments six months after

the initial report. In addition, the Secretary shall appear, if

requested, before both committees to provide testimony on these

reports.

(b) Contents of Report.-Each report submitted under subsection

(a) shall contain-

(1) an analysis of currency market developments and the

relationship between the United States dollar and the

currencies of our major trade competitors;

(2) an evaluation of the factors in the United States and

other economies that underline conditions in the

currency markets, including developments in bilateral

trade and capital flows;

(3) a description of currency intervention or other actions

undertaken to adjust the actual exchange rate of the

dollar;

(4) an assessment of the impact of the exchange rate of the

United States dollar on

(A) the ability of the United States to maintain a more

appropriate and sustainable balance in its current

account and merchandise trade account;

(B) production, employment, and noninflationary

growth in the United States;

(C) the international competitive performance of

United States industries and the external indebtedness of the United States;

(5) recommendations for any changes necessary in United

States economic policy to attain a more appropriate

and sustainable balance in the current account;

(6) the results of negotiations conducted pursuant to section

3004;

(7) key issues in United States policies arising from the

most recent consultation requested by the International

Monetary Fund under article IV of the Fund’s Articles

of Agreement; and
Department of the Treasury

Annual Report to Congress on International Economic and Exchange Rate Policy

Period Covered: November 1, 1998 to June 30, 1999

Page 14

(8) a report on the size and composition of international

capital flows, and the factors contributing to such flows,

including, where possible, an assessment of the impact

of such flows on exchange rates and trade flows.

(c) Report by Board of Governors.-Section 2A(1) of the Federal

Reserve Act (12 U.S.C. 225a(1)) is amended by inserting after

“the Nation” the following:”, including an analysis of the impact

of the exchange rate of the dollar on those trends”.

SEC. 3006. DEFINITIONS.

As used in this subtitle:

(1) Secretary.-The term “Secretary” means the Secretary of the

Treasury.

(2) Board.-The term “Board” means the Board of Governors of

the Federal Reserve System.