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The Trump administration is clearly irked by the fact that the recent depreciation in China’s currency partly offsets the tariffs the administration has imposed on US imports from China. “I think China is manipulating their currency, absolutely,” Trump said back in August. His comments and warnings by others had led to considerable speculation in the financial press about whether the US Treasury would name China a currency manipulator for allowing its currency to fall against the dollar.
On October 18, however, the US Treasury released its Foreign Exchange Report, without labeling China or any other country a currency manipulator. But Treasury Secretary Steven Mnuchin was reported to have said afterwards that he was open to changing the criteria Treasury uses to identify currency manipulation.
Treasury’s analysis can certainly be improved, but no sensible changes would lead to the conclusion that China has manipulated its currency so far this year. Meanwhile, some other countries that manipulate their currencies continue to evade Treasury’s designation.[1]
Congress has mandated Treasury to look at foreign exchange policies around the world every six months and declare whether any of our major trading partners has been a manipulator. The concept of currency manipulation originates in the Articles of Agreement of the International Monetary Fund (IMF). IMF member countries are supposed to “avoid manipulating exchange rates or the international monetary system in order to prevent effective balance of payments adjustment or to gain an unfair competitive advantage over other members.” The key components of currency manipulation are that a country has a significant current account (trade) surplus and that it has supported this surplus by excessive official purchases of foreign currency assets, which keep its currency—and thus its export prices—undervalued. Treasury’s criteria for these components are sensible, and China does not even come close to meeting either of them. In the first half of 2018, China’s current account balance and official foreign currency purchases were close to zero.
The decline in the value of China’s currency is exactly what economic theory says should happen to a country that faces higher tariffs on its exports. Apparently, this textbook response caught the administration by surprise. It is true that China heavily manages its exchange rate, and it could have prevented any depreciation had it wished, in part by using its foreign exchange reserves to buy back its own currency. But China’s trade-weighted exchange rate is only back to around where it was in January 2017, at the beginning of this administration. And China has not taken any active steps to push its currency down further. So there are very scant grounds for complaint.
Some have argued that the manipulation criteria for official foreign currency purchases should be modified to allow for an effect of past purchases in countries that have excessively large stocks of such assets. China’s foreign exchange reserves, at $3 trillion, are indeed excessive. But the evidence shows that the lingering effects of such stocks are modest, especially for countries such as China that have significant restrictions on private capital flows.[2] Any serious attempt to address this issue would have far greater implications for countries such as Norway and Singapore than for China.
As was the case in its previous report, Treasury continues to use two other criteria to shield countries that are manipulating their currencies from being so designated. Brad Setser points out that expanding the scope of Treasury’s investigation to the top 25 US trading partners would cause Thailand and Vietnam to be designated as manipulators. Lowering the bilateral surplus threshold from $20 billion to $15 billion would cause Switzerland to be designated. Eliminating the bilateral surplus criterion, which was required by Congress but has no economic rationale, would cause Singapore to be designated. And adding official foreign currency purchases that are not classified as reserves (such as government pension funds and sovereign wealth funds) might lead to designation of South Korea or Norway as manipulators.[3]
Shining a spotlight on countries other than China might distract from the conflict over China’s policies on intellectual property and strategic development. But, if the goal is to narrow the chronic US trade deficit, it is essential to tackle countries that are currently contributing to the problem. The United States needs a coherent, fair, and balanced approach that is not distorted to go after perceived enemies while ignoring those who are perceived to be friends.
Notes
1. For other takes on Treasury’s report, see those by Mark Sobel and Stephanie Segal.
2. See, for example, the tables in my recent working paper.
3. Data on these purchases are reported with a long lag and are not available for some countries.
