photo: Steve Passlow
Allegations Of Currency Manipulation
Accusing trading partners of currency manipulation has become fashionable among American politicians. Donald Trump has accused China of manipulating the Renminbi to the disadvantage of Americans. Hillary Clinton recently announced her opposition to the TransPacific Partnership trade agreement because it lacks sufficient protection against currency manipulation. In this age of extreme political polarization, concern about currency manipulation has brought the two parties together. Democratic Senator Schumer and Republican Senator Lindsey Graham have demonstrated bipartisan opposition to China’s currency policies. They have proposed a specific tariff against Chinese goods unless China abandons its alleged currency manipulation. In another bipartisan effort, Republican Senator Rob Portman and Democratic Senator Debbie Stabenow proposed a new bill to punish currency manipulators (Klein).
Failure to Detect Currency Manipulation
Not everyone finds China guilty of currency manipulation, and many economists find the basic concept of currency manipulation to be seriously flawed (Sanford 2011). In its latest evaluation of China’s currency practices, the IMF concluded that the Renminbi was not undervalued. (IMF). Also on November 30, the IMF implicitly endorsed China’s currency practices by giving the Renminbi reserve currency status. By law the US Treasury must monitor currency practices and report to Congress on possible currency manipulation. In its October 19 report, the Treasury again found that China is not a currency manipulator (U.S. Treasury). More generally, the concept of currency manipulation is so vague and imprecise that it is difficult to determine objectively whether a currency is being manipulated. Quite apart from the legality of the practice, is currency manipulation even unethical? Dante Alighieri’s Divine Comedy identified levels of Hell that punished greed, fraud, usury, and even gluttony, but there was no place reserved for currency manipulation. Did Dante lack foresight, or is it possible that currency manipulation is too vague and subjective to deserve punishment?
Vagueness of Currency Manipulation
What exactly is currency manipulation? The most common definition is that it is a cheapening of currency to gain an unfair trade advantage. Currency depreciation is objectively discernible, but the reason for a currency losing value may have nothing to do with a government official’s motive to acquire a trade advantage. Capital outflows in response to higher rates of return abroad contribute to currency depreciation. Also a decline in the price of a major export will contribute to currency depreciation, as Saudi Arabia, Russia, and other oil exporters have discovered in 2015. These depreciations are obviously not favorable for the economies of oil exporters. Also declining currencies may be a side effect of legitimate economic policies aimed at other targets. In the wake of the crisis in the 1990s that resulted in massive depreciations and overshooting of several emerging market currencies (EMEs), a number of EMEs sought to hedge against a repeat of that scenario, and set a policy goal of building up their foreign exchange reserves. To do that requires them to maintain an exchange rate that undervalues the domestic currency for a certain period.
The European Central Bank is involved in Quantitative Easing aimed at its “close to but below 2%” inflation goal, but a side effect has been a substantial depreciation of the Euro relative to the dollar. Is the ECB guilty of currency manipulation? When will Schumer and Graham extend their criticism, of China to the ECB? Japan had its own Quantitative Easing, that resulted in a depreciated yen. Earlier the Federal Reserve carried out its own Quantitative Easing that resulted in a decline in the value of the dollar. Were the Bank of Japan and the Fed guilty of currency manipulation? Janet Yellen has anticipated currency manipulation charges against the Fed, and she has testified before Congress against including currency manipulation clauses in trade agreements.
Institutions and Currency Rules
Who establishes rules for currency values, and what are the rules? All major trading countries are members of the International Monetary Fund. Prior to 1974, all members were obliged to have fixed exchange rates, subject to occasional discrete changes in values, but floating exchange rates were legitimized by the Fund after 1974. Today some members have fixed rates while others float, and both regimes are recognized as legitimate by the IMF. Because the dollar floats against major currencies, when China fixes its exchange rate against the dollar, the Renminbi floats against other major currencies, such as the Euro and the Yen. The IMF has some vague rules against overvalued or undervalued currencies, but its methods for measuring currency misalignment are multiple and subject to change. In its latest assessment of China’s currency practices, the IMF concluded that the Renminbi is not misaligned (IMF 2015).As a practical matter, the IMF has never punished a member for having a misaligned exchange rate.
In the US, Congress passed a law against currency manipulation in 1988 that requires the Treasury to monitor the currency practices of partner countries and report to Congress twice a year on possible currency manipulation. The Treasury has never identified countries that have engaged in currency manipulation, and their October 2015 report concluded that China is not currently manipulating its currency. Senators Schumer and Graham have been threatening to punish China for currency manipulation since 2003. Their bill proposes a 27.5% tariff against Chinese goods as long as China continues currency manipulation. They claim that the tariff rate is the mean value of two studies done before 2003 on the degree of undervaluation of the Chinese currency. The bill remains a threat against China, but it has not yet been passed by the Senate. Schumer remains firmly opposed to China’s currency practices. In his response to the IMF adding the Renminbi to its SDR currency basket, he said “the IMF is choosing to reward China’s currency manipulation instead of combating it” (WSJ 2015b).
Recent Exchange Rate Data for China
China has managed its bilateral exchange rate against the dollar. It has announced a central rate that it changes from time to time, and it allows limited movement around the central rate. Allegations of currency manipulation are based on the large accumulation of dollar reserves that occurred at the managed exchange rates and the large bilateral trade surplus with the US. However, in recent years the Renminbi has become more flexible and the trade surplus has become smaller. The Renminbi has appreciated against the dollar by 35% in the last decade (Klein). When the Renminbi was fixed against the dollar it floated against other currencies. Against the average of the dollar and other currencies, and adjusted for inflation, the Chinese currency appreciated 50% in the last decade (Klein).The announced change in the reference rate for the Renminbi August 11 of 2015 was followed by a depreciation of 2.3% through September. However, capital outflows caused the Bank of China to sell significant dollar reserves to prevent the Renminbi from depreciating further than it did (U.S. Treasury). China’s growth rate has decreased, and it is forecast to continue to decline in the future (Federal Reserve Bank of Dallas). China is also experiencing labor shortages and rising labor costs, and some manufacturers have already moved production to Vietnam and Malaysia, where labor costs are lower (Wall Street Journal, 2015C). If China moves toward more market-determined exchange rates, Senators Schumer and Graham might be surprised to see the Renminbi depreciate relative to the dollar.
Currency Values and Inflation
A cheaper Renminbi, by itself, does not give Chinese exporters an advantage in trade. One must also know the inflation rate in China. For example, let the exc hange rate drop from $.10 per yuan to $.05 per yuan, but suppose prices rise in China from 100 yuan to 200 yuan. The US dollar price of Chinese goods would be$10 both before and after depreciation of the Renminbi. Cheapening of the Chinese currency does not affect trade, if the cheapening just offsets Chinese inflation. Even if the Chinese currency were undervalued against the dollar in earlier years, it might no longer be true if China has had higher inflation recently. Thus, the inflation-adjusted or real exchange rate is relevant for trade, not just the money exchange rate. In this example, the real exchange rate is constant, and there is no trade advantage from depreciation of the money exchange rate. In fact, the Renminbi has appreciated against the dollar in real terms in recent years (Klein).
It has become fashionable for politicians to accuse trading partners of currency manipulation. In the U.S., prominent Democrats and Republicans have accused China of misusing its currency to gain a trade advantage. At the same time, institutions that have been asked to monitor exchange rates have failed to find China guilty of currency manipulation. One possible explanation for differences between accusers and monitors is that the concept is so vague and subjective that it is fundamentally flawed. To determine the “correct” or equilibrium value of a currency requires an economic model, and there is no consensus as to what the best model is. Hence, there is no unique “correct” value for a currency to compare with the alleged “manipulated” value. Also if a currency depreciates, there is no reliable way to determine the motive of the policymaker who may have influenced the depreciation. A responsible central banker pursuing an inflation target may contribute to currency depreciation as a side effect of quantitative easing. A strong case can be made for abandoning the concept of currency manipulation as not workable. It is one more pseudo-scientific argument used by protectionists to shield themselves from competition that would benefit consumers.
Federal Reserve Bank of Dallas. 2015. “Long View of China Suggests Inevitable Slowdown.” Economic Letter, October.
International Monetary Fund. 2015. “IMF Staff Completes the 2015 Article IV Consultation Mission to China”. May 16.
Klein, Michael W. 2015. “What You May Not Know About Currency Manipulation”. Brookings Institution. May 22.
Sanford, Jonathan. 2011. “Currency Manipulation: the IMF and WTO”. Congressional Research Service. January 28.
Trump, Donald. 2015. “Ending China’s Currency Manipulation”. Wall Street Journal, November 10.
Wall Street Journal. 2015b.”China Joins World’s Elite Currency Club”. December 1.
Wall Street Journal. 2015a. “Dollar’s Revival Poses New Threat”. November 18.
Wall Street Journal. 2015c. “China Loses Edge on Labor Costs”. December 3.
U.S. Treasury. 2015. “Report to Congress on International Economic and Exchange Rate Policies”. Office of International Affairs, October 19.