The Treasury has designated China a ‘currency manipulator’. The last time the Treasury has named a country a currency manipulator was in 1994 (China). The recent decision was a surprise, for the Treasury must have changed the criteria it uses to establish currency manipulation. The decision appears to be politically motivated. This is supported by a Washington Post article that says that the White House put significant pressure on the Treasury to name China a currency manipulator.
Two statutes regulate the issue of currency manipulation. US legislation pertaining to currency policy consists of (1) the Omnibus Foreign Trade and Competitiveness Act (1988) and (2) the Trade Facilitation and Trade Enforcement Act (2015). As recently as May 2019, the Treasury assessed currency manipulation on the basis of three criteria it had established pursuant to the 2015 legislation For a country to be designated a currency manipulator it needs to meet all of the following criteria. It must:
- Run a substantial bilateral trade deficit with the US defined as exceeding USD 20 bn
- Run a current account surplus in excess of 2% of GDP
- Engage in sizable one-sided currency intervention translating into net FX purchases larger than 2% of GDP (previously 3%)
China only seems to meet the first of the three criteria at the moment. As Brad Setser points out, the Treasury may have followed the 1988 Omnibus Act, where currency manipulation is not defined numerically, rather than the 2015 statute, and this gives the Treasury more leeway. Alternatively, the Treasury may have changed or adjusted the criteria it uses to assess currency manipulation. Either way, the decision undoubtedly points to the increasing politicization of the assessment process.
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| Source: IMF |
Designating China a manipulator is economically problematic. First, China’s equilibrium exchange rate is not significantly mis-aligned and the current account is close to balance. So China does is not manipulating its currency in order to keep the RMB artificially undervalued. True, China does run a large bilateral trade surplus with the US. But economically this is a fairly meaningless measure. Even if bilateral (rather than global) trade balances mattered in economic terms, China’s contribution to the overall US trade deficit is far smaller in (economically relevant) value-added terms than in dollar terms. The lack of logic of focussing on bilateral balances becomes readily apparent if one imagines what would happen if all countries sought to reduce their individual bilateral trade balances to close to balance.
China does have greater control over its exchange rate than many other countries. Capital controls, tight oversight of the on-shore FX markets, dealers and financial institutions combined with USD 3 tr worth of FX reserves do give the Chinese authorities significant influence over the RMB and allow China to operate a managed exchange rate. China’s exchange rate was undoubtedly undervalued a decade or so ago when its current account surplus reached 10% of GDP. To the extent China has sought to influence its exchange rate more recently, however, it has sought to prevent excessive currency weakness (e.g. 2015). Politically, this makes sense because a sharp currency weakening would have further inflamed the trade conflict. Admittedly, it is not for the Treasury to opine on whether a large bilateral surplus warrants the currency manipulation designation. The legislation says it does. It is obviously also possible to say that an economy with a managed exchange rate manipulates its currency. But it is difficult to make sense of the Treasury’s decision on the basis of the conditions it established pursuant the 2015 Act.
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| Source: IMF |
Naming China a currency manipulator will not help Washington prosecute its trade war against China more effectively. The statute(s) do oblige the Treasury to take remedial action in case another country runs “significant bilateral trade surpluses with the US” and they demand that the Treasury start negotiations with the designated manipulators. The 2015 legislation is a little more concrete in terms of the actions to be taken and the sanctions to be imposed. These (1) denial of financing/risk insurance on new investment (in China) through the Overseas Private Investment Corporation; (2) denying (Chinese) firms access to the US government procurement market; (3) seeking additional IMF surveillance; and (4) taking into account (Chinese) currency practices in the negotiation of new trade agreements. The economic and financial impact of measures (1) and (2) is very modest. It is difficult to see how the IMF will take on one of its major shareholders on the issue. (It did not work last time (Walter 2014) and the prospect of signing a trade agreement appears far off and, if it happens, will of course have to address currency issues. Washington will make sure it does.
By invoking national security, the US administration already has substantial leeway to take strong economic measures against China (Section 232, 1962 Trade Act), not to mention measures on the grounds of intellectual property rights theft and industrial policy practices (Section 301, 1974 Trade Act) and safeguards (Section 201, 1974 Trade Act). Moreover, the updated CFIUS legislation (Foreign Investment Risk Review Modernization Act, 2018) now allows for greater vetting of Chinese investment in the US and the new export control regime (Export Control Reform Act, 2018) effectively allows the US to restrict (broadly defined) technology goods exports and transfers, allowing the US to target individual Chinese companies (so-called Commerce Department Entity List). The most recent suggestion that the US administration might invoke the 1977 International Emergency Economic Powers Act (IEEP) to force US companies, theoretically at least, to stop doing business with China. The policy options offered to the US administration on the basis of currency manipulation pale in comparison to the IEEP Act.
Some analysts have suggested that designating China a currency manipulator might be a first step towards taking more radical measures, such as counter-veiling currency interventions. Countervailing currency intervention was first proposed by Bergsten & Gagnon (2012). In order to get countries that consistently undervalue their currency to adjust, they proposed the US undertake ‘countervailing currency intervention’, that is, buying the same amount of currency that the manipulating country purchases in order to neutralize the effect of the latter’s policy on the exchange rate. Acknowledging that this policy won’t work in the case of a (relatively) non-convertible currency like the RMB, they also suggested second-best measures such as a tax on the earnings of dollar assets held by the manipulating country or even restrictions on the purchase of dollar assets altogether. If this does not work, they advocate countervailing imports duties to offset what they regards as an implicit export subsidy, namely an undervalued exchange rate.
The snag is that the US Treasury is bound to have insufficient firepower to make good on such a threat unless the Fed can be persuaded to support the policy. The White House seems to have persuaded Treasury to disregard its own rulebook when it comes to currency manipulation. Getting it to decide in favour of countervailing currency intervention won’t be too difficult and the Treasury has jurisdiction over currency policy, including the discretionary use over the Exchange Stabilization Fund (Henning 1999). The problem is that the fund’s firepower is very small. And even if the Fed were to match Treasury FX intervention, as it has done in the past, the intervention amount would be too limited to make a significant difference to the exchange rate. First, the Fed intervenes in the FX only rarely. It bought Japanese yen in 1998, euros in 2000 and sold Japanese yen in 2011. The Fed will be very reluctant to commit to massive, potentially open-ended currency intervention targeting China It would risk undermining its crediblity and independence and might weaken its ability to meets its statutory objectives. The Fed risks triggering major international and domestic economic and financial stability by supporting such an economically aggressive policies.
True, the size of the RMB off-shore market is small and much of it is quite illiquid and it therefore may not take much FX intervention to move prices. On the other hand, the PBoC (and state-owned Chinese banks) would seek to stabilize markets through counter-intervention and through administrative controls seeking to insulate the domestic market and stablise the external value of the RMB. This would no doubt be disruptive, not least psychologically for global financial markets. For US threats to be credible and effective, the Treasury would very likely need to the Fed’s buy-in. This seems unlikely to be forthcoming. Moreover, US policy would need to be able to impose significant economic pain on China, before China will make concessions. After all, Beijing would be loath to be seen as giving in for fear of encouraging further US pressure. So there are real question markets over US policy in terms of their technical success, their domestic-political feasibility and their international political effectiveness.
Naming China a currency manipulation may primarily reflect increasing sense of US frustration about its continued failure to coerce China into a trade agreement. The limited success of the trade war and increasing concerns that a prolonged war could tip the US and the world economy into a recession. With signs of the global economy slowing or at least becoming more fragile, in part because of trade tensions, further trade measures would weaken the US economy less than 15 months before the next presidential elections. A weakening US economy strengthens China’s bargaining position. It therefore makes sense for Washington to up the ante and make very strong threats in order to (be seen as) get to an agreement with China.
For threats to be effective, however, they need to be credible. Brinkmanship is an important element of threat bargaining. Designating China a currency manipulator and threatening to force US business to cut ties with China are then perhaps just part and parcel of a maximum pressure campaign – a campaign whose credibility is somewhat in doubt. To the extent that the global economy is weakening and the 2020 presidential elections are approaching, the credibility of US threats is beginning to decline. This does not mean that the US is not going to make good on these threats. But if Washington wants to use threats to persuade China to come to an agreement, it needs to convince Beijing that it is serious about carrying them out. Credibility requires that carries out some of the threats (signaling). Recent US actions are casting doubt on Washington’s willingness to incur substantial economic costs in the pursuit of an agreement. The US refrained from imposing tariffs on China to the full extent threatened during the recent round of retaliation, currency manipulation does not provide the administration with new and more threatening tools to cajole China and threatening to cut economic ties with China does appear to be a bluff given the economic and political consequences this would have in the US and the political opposition it would mobilise domestically. The bottom line is that the decision to name China a currency manipulator is economically dubious. It is concerning in terms of the Treasury’s institutional independence. But it is not going to be a game-changer as far as the US-China economic conflict is concerned.