# **I. INTRODUCTION**

In the protracted Doha Round of multilateral trade negotiations of the World Trade Organization (WTO), countless negotiating hours have been expended on realizing outcomes in agriculture and manufacturing that would have minimal trade effects. Thus, in the market access negotiations on manufacturing, an optimistic outcome would yield actual tariff cuts by developing countries on average of about 2 to 3 percentage points and only slightly higher cuts by industrial countries (Martin 2007). In the agriculture negotiations, cuts in actual domestic support for the United States would be mostly notional and for the European Union not much greater than those that are already planned to deal with the fiscal consequences of Eastward expansion. And the reductions in applied agricultural tariffs will probably only be 3 to 4 percentage points on average once the likely exemptions for sensitive and special products are taken into account (Anderson, Martin, and van der Mensbrugghe 2006).

In contrast, exchange rate changes—in particular persistent undervaluation of major currencies—these last few years have been substantial, leading to one of the most pressing contemporary problems: global imbalances. For example, estimates of China’s exchange rate suggest a sizable undervaluation for the 2000–2007 period, ranging from 20 to 60 percent (Cline and Williamson 2007 and Chart 1). Eliminating this undervaluation is estimated to reduce China’s current account surplus by between 6 and 12 percentage points of GDP, or between $150 billion and $300 billion (Goldstein and Lardy 2007).

But undervaluation is not confined to China. Take the case of eight large oil exporters for which exchange rate data are available. Chart 2 depicts the evolution in their real exchange rates juxtaposed with real oil prices. Between end-2001 and July 2007, real oil prices increased by about 250 percent. During this period, five of the eight countries (the United Arab Emirates, Kuwait, Saudi Arabia, Bahrain, and Venezuela) have seen their real exchange rate _depreciate_ by about 20 percent on average. The remaining three countries (Norway, Russia, and Iran) have seen appreciations, averaging about 24 percent.

Exchange rates and exchange rate policies of oil-exporting countries are, of course, shaped by special factors. Even allowing for the differing circumstances of oilexporting countries in terms of the dominance of the oil sector and the magnitude of proven reserves, however, real depreciations or modest appreciations in the face of a large, and plausibly permanent, positive price shock appear odd (Frankel 2006, Setser 2007). Jaewoo Lee, Gian-Maria Milesi-Ferreti, and Luca Ricci (2007) estimate that a 100 percent increase in real oil prices leads to a long-run real appreciation of the currencies of oil-exporting countries of about 50 percent. By that yardstick, oil-exporting countries’ currencies should have appreciated in real terms by 125 percent. Of course, the short-run impacts are likely to be smaller. But even in the short run, the trade consequences need not be small. Under crude assumptions, we estimate that imports of oil-exporting countries could have been greater by about $200 billion or more.

Thus, between China and the oil-exporting countries, moving toward more appropriate levels of exchange rates could have increased world trade by about half a