How Not to Fight a Currency War

Branding China a “Currency Manipulator” Will Only Hurt the United States

Earlier this month, the United States officially branded China a currency manipulator. Trade hawks have long argued that Washington should call out Beijing for holding down the value of its currency in order to unfairly boost its exports. But ironically, U.S. President Donald Trump picked a time when China wasn’t actually suppressing the yuan to formally brand it a manipulator. Although it has certainly manipulated its currency in the past, China stopped doing so in 2014. Yet Trump, upset by the yuan’s depreciation during the first week of August and frustrated by a lack of progress in U.S.-Chinese trade talks, reportedly pressed Treasury Secretary Steven Mnuchin to make the designation over Mnuchin’s own objections.
 
The designation is largely symbolic. Under the legislation cited by the U.S. Treasury Department, the penalty will be a year of negotiations between the United States and China, either directly or through the International Monetary Fund (IMF). In fact, the only way that the Treasury was able to designate China was through an expansive reading of the Omnibus Trade and Competitiveness Act of 1988, whose criteria for manipulation include any action in the foreign exchange market aimed at “gaining an unfair advantage in international trade.” China doesn’t meet the more technical definition of manipulation set forth in the Trade Facilitation and Trade Enforcement Act of 2015, which considers a country’s bilateral trade balance with the United States, whether it is a net lender to the rest of the world, and the extent of its intervention in the foreign exchange market. Both laws are currently on the books, and some aspects of the 1988 law actually might be better suited to addressing real cases of manipulation, but Trump’s use of the earlier law to designate China was nothing more than cheap theater.
 
That’s not to say the U.S. president didn’t highlight a real problem: with two flawed laws defining currency manipulation on the books, the United States lacks both adequate criteria for identifying currency manipulation and effective tools for responding to it. Unfortunately, branding China a manipulator at a time when it is not actually manipulating its currency will only make it harder to take a tough line against real manipulation in the future.
 




United States Trade Representative Robert Lighthizer (C) gestures as he chats with Chinese Vice Premier Liu He (R) as US Treasury Secretary Steven Mnuchin (L) looks on after posing for a "family photo" at the Xijiao Conference Centre in Shanghai on July 31, 2019. (Getty)

 ONCE A MANIPULATOR, NOT ALWAYS A MANIPULATOR
 
Currency manipulation occurs when a country that runs a large trade surplus intervenes in the foreign exchange market with the aim of artificially depressing the value of its currency and making its exports cheaper on the global market. Although standard macroeconomic policies, such as cutting interest rates or buying domestic financial assets, can affect exchange rates, manipulation—correctly defined—is conceptually different. Whereas the aim of the former policies is to ease domestic financial conditions, the purpose of manipulation is simply to weaken a currency or to keep it from rising when it should. Governments typically accomplish this by purchasing foreign currencies and selling their own, artificially decreasing the demand for the latter.
 
Genuine manipulation can sometimes be difficult to identify, as countries may have legitimate, prudential reasons for intervening in the foreign exchange market. When a country receives large financial inflows, for example, it may wish to build up foreign exchange reserves in case those financial inflows reverse. Heavily indebted countries that run trade deficits also need to hold foreign exchange reserves to limit the risk of a crisis. But if the intervention is done by a country with a large trade surplus, then it is probably manipulation—a policy directed primarily at keeping the country’s trade surplus high rather than managing its domestic economy.
 
China began manipulating its currency roughly 15 years ago, several years after its 2001 entry into the World Trade Organization provided a massive jolt to its economy. Under normal circumstances, the rapid growth that followed would have caused the value of the yuan to increase. Yet Beijing, which was determined to keep its exports cheap, refused to let its currency rise against the dollar, buying up foreign exchange reserves to artificially deflate the value of the yuan. China’s manipulation during this period was one reason for the so-called China shock—the rapid fall, in the first decade of the current century, in manufacturing employment in U.S. and European regions that compete most directly with China.
 
Yet China stopped manipulating its currency in the second half of 2014, when the dollar strengthened significantly as a result of the Federal Reserve’s decision to start raising interest rates and the European Central Bank’s decision to begin quantitative easing. At the time, the yuan was tightly linked to the dollar, so the dollar’s rise pulled the yuan’s value up against many of China’s trading partners, putting additional stress on its weakening economy. Amid the resulting market uncertainty, many Chinese savers started to worry that the yuan might depreciate and sought to move their funds out of China. As a result, Beijing no longer needed to buy large sums of dollars in the foreign exchange market to keep the yuan from rising. On the contrary, it at times had to sell dollars (and buy yuan) to keep the yuan from falling in value.
 
Beijing still doesn’t allow its currency to float freely—the Chinese central bank manages the market value of the yuan through means other than foreign exchange purchases, for instance by setting the center point for the yuan’s daily trading range. But today it is using these tools to keep the yuan from falling even faster than it has in recent weeks. The yuan easily could be between three and five percent weaker if China were not managing its value.
 
Previous U.S. administrations made a political decision not to designate China a currency manipulator. Because the relevant legislation did not specify any real sanction for currency manipulation, top officials in the George W. Bush and Obama administrations argued that the designation would amount to name-calling without genuine consequences. They also worried that it would lead Congress to take matters into its own hands and impose sweeping tariffs on China, undermining what was believed to be the United States’ broader interest in integrating Beijing into the world economy. The Trump administration’s decision to designate China was equally political: Trump didn’t like that the yuan had depreciated against the dollar, which he feared would harm U.S. exports.
 
WRONG TARGETS, WORTHLESS WEAPONS
 
There are legitimate reasons for the United States to be concerned about currency manipulation: currency manipulators effectively make it harder for their trading partners to grow their economies, especially under economic conditions such as the present, marked by weak demand, too much saving, and low interest rates. But a serious policy needs to be based on a well-defined process that sets out clear criteria for assessing a country’s actions in the foreign exchange market. The goal should be to deter countries from manipulating and name them only if they ignore clear warnings. That’s quite different from Trump designating China out of frustration.
 
A better set of criteria for designating currency manipulators would take as a starting point a different portion of the Omnibus Trade and Competitiveness Act of 1988 than the “unfair advantage” criterion Trump has seized on: a portion that emphasizes actions that “impede effective balance of payments adjustment”—that is, policies designed to preserve a large trade surplus. It would then look not at a country’s bilateral trade balance with the United States, as the 2015 law does, but at the country’s overall trade balance and its direct activity in the foreign exchange market.
 
In a world of global value chains, a country’s trading balance with the United States isn’t a good guide to whether it’s manipulating its currency. Countries such as Singapore and Taiwan, for instance, have a history of unfair currency policies. But because they export high-end electronic components to China and Vietnam for final assembly rather than selling directly to the United States, the current set of ill-defined standards lets them off the hook. Washington should also more rigorously assess other countries’ actions in the foreign exchange market. Currently, it looks narrowly at the actions of a country’s central bank. It should expand this assessment to include an evaluation of whether a country’s state-owned banks and investment funds are helping to weaken its currency.
 
Basing any claim of manipulation on a clear definition is especially important if a finding of manipulation is to be paired with real penalties. Right now, it isn’t. The 1988 law requires nothing more than a year of negotiations, and although the 2015 law calls for some sanctions, such as enhanced IMF surveillance or the loss of risk insurance through the U.S. Overseas Private Investment Corporation, these are largely pinpricks. The right penalty would be counterintervention by the United States—purchasing the currency of the manipulating country in order to push its value back up. Washington already has the legal authority to do this via the Treasury Department’s Exchange Stabilization Fund, a reserve fund authorized to deal in foreign exchange. But right now the fund has only around $100 billion in assets—enough for a currency war with a small power but not a major one such as China. Congress could appropriate more money for the fund in order to establish a more effective deterrent.

Trump’s decision to brand China a currency manipulator at a time when it doesn’t meet any sensible definition of manipulation was a mistake, even if the designation itself has few legal consequences. But it highlights how U.S. currency policy effectively amounts to going after the wrong targets with a worthless weapon. A better policy would make sure the United States not only names the right targets—those that are actively buying large amounts of foreign exchange in the market to hold their currencies down—but ensures there are real penalties for offending countries if they don’t change their behavior.
 
This article was originally published on ForeignAffairs.com.
 


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