The U.S. Senate recently passed the “Currency Exchange Rate Oversight Reform Act of 2011.” This proposed legislation is very questionable. It purports to give a populist answer to a very complex set of problems. These problems include market access, recognition of intellectual property rights and cybersecurity.

The proposed legislation would allow the undervaluation of a foreign currency to be considered as a factor in determining an illegal subsidy. Technically, such undervaluation would be viewed under the WTO rules as an “actionable subsidy” allowing a countervailing duty in the form of a tariff surcharge. This is through by imposition of countervailing duties by the United States via the International Trade Commission / International Trade Administration process. This type of protectionist action in the midst of a global slowdown could lead almost inevitably to a trade war with China.

Here are two major problems, among many others, concerning the proposed legislation relating to the World Trade Organization (WTO) and third-party countries (countries other than China).

One, the U.S. legislation is simply not consistent with WTO rules. WTO rules concerning subsidies and currency obligations do not regulate general currency or monetary policies. Action by China against the U.S. in the WTO is  almost certain. (China is a very active litigant in the WTO’s dispute resolution process.)

Two, the rule of unintended consequences may come into play. Actions could be brought by U.S. firms against imports from countries other than China. This is because the language of the legislation is general and not specific to China. This might well involve litigation against countries such as Japan, Switzerland and Brazil. In addition, countries may bring actions against the U.S. and U.S. exports under their own laws and interpretation of WTO rules.  Countries have been critical of  the U.S. monetary policy of quantitative easing and proposals for future easing.  They argue this monetary policy leads to undervaluation of the dollar (“cheap dollar”) and helps U.S. exports, which of course it does. The issue of competitive devaluation is always lurking underneath the surface.

Merely filing subsidy actions in the U.S. against Chinese imports would most likely result in more trade friction with China. This is just what we do not need in the midst of this economic mess. Negotiations with China are more appropriate than more trade friction and increased global trade litigation.