A rare issue on which the two parties in the US Congress agree is the problem of “currency manipulation,” especially on the part of China. Perhaps spurred by the 2014 appreciation of the dollar and the first signs of a resulting loss of American net exports, Congress is once again considering legislation to attack currencies that are seen as unfairly undervalued. The proposed measures include the threat of countervailing duties against imports from offending countries, although that would be inconsistent with international trading rules.
Even if one accepts the possibility of identifying a currency that is manipulated, however, China no longer qualifies. Under recent conditions, if China allowed its currency to float freely, without intervention, the renminbi would more likely depreciate against the dollar than appreciate. US producers would then find it harder to compete on international markets, not easier.
The concepts of manipulation or unfair undervaluation are exceedingly hard to pin down from an economic viewpoint. That China’s renminbi depreciated slightly against the dollar in 2014 [2%] is not evidence: Many other currencies, most notably the yen and euro, depreciated by far more last year. As a result the overall value of the renminbi was actually up slightly on an average basis during 2014 [3%], reaching an all-time high.
The sine qua non of manipulation criteria is intervention in the foreign exchange market: selling the domestic currency, in this case, the renminbi, and buying foreign currencies, the dollar, so as keep the foreign exchange value of the domestic currency lower than it would otherwise be. To be sure, the People’s Bank of China did a lot of this over the preceding ten years. Capital inflows on top of trade surpluses contributed to a huge balance of payments surplus. The authorities bought the dollars needed to make up the difference, the excess supply of dollars. The result was an all-time record level of foreign exchange reserves, reaching $3.99 trillion by July 2014.
The situation has recently changed, however. In 2014, net capital inflows into China reversed and turned to substantial net capital outflows. As a result, the overall balance of payments turned negative in the second half of the year, which constitutes an excess demand for dollars or excess supply of renminbi. The People’s Bank of China actually intervened to dampen the depreciation of its currency against the dollar, the opposite of its actions over the preceding decade. As a result, foreign exchange reserves fell to $3.84 trillion by January 2015.
There is no reason to think that this recent trend will necessarily reverse in the near future. The downward market pressure on the renminbi relative to the dollar is easily explained by the current pattern of a relatively strong economic recovery in the US, prompting the end of a period of American monetary easing, together with a weakening of economic growth in China, prompting the start of a new period of monetary stimulus there.
Similar economic fundamentals are now at work in other countries, particularly Japan and euroland. When the American congressmen propose to insert currency provisions into the Trans-Pacific Partnership, even though it is currently in its final stages of negotiations, they are presumably targeting Japan. (China is not included in this trade agreement.) They may also want to target the Eurozone in coming negotiations for the Transatlantic Trade and Investment Partnership. Both the yen and euro have depreciated sharply against the dollar over the last year.
But, unlike China, it has been years since the Bank of Japan and the European Central Bank intervened in the foreign exchange market. They accepted a proposal by the US Treasury to refrain from unilateral foreign exchange intervention, in an unheralded G7 ministers’ agreement two years ago.
Then what do those who charge Japan or the Eurozone with pursuing currency wars by pushing down the values of their currencies have in mind? They have in mind the renewed monetary stimulus of recent quantitative easing programs by those central banks. But, as the US government knows well, countries with a deficiency of demand can’t be asked to refrain from increasing the money supply or decreasing interest rates just because the likely effects include a depreciation of the currency. One cannot even say that the likely effects include a “beggar-thy-neighbor” rise in the trade balance, because the exchange rate effect is counteracted by an income effect that boosts imports.
Indeed in 2010 it was the US that had to explain to the world that money creation is not currency manipulation. At the time, it was the country undertaking quantitative easing and was accused by Guido Mantega, the Brazilian Finance Minister who coined the “currency wars” phrase, of being the prime aggressor. The US hasn’t intervened in the foreign exchange market to sell dollars in a major way since the 1985 coordinated interventions associated with the Plaza Accord, which began precisely 30 years ago this month. (There was also a smaller intervention to sell dollars in 2000, to help the euro.)
There are other criteria besides foreign exchange intervention that are used to ascertain whether a currency is undervalued or even “manipulated” for “unfair competitive advantage,” language that is in the IMF Articles of Agreement. One criterion is an inappropriately large surplus in its trade balance or current account balance, relative to GDP. Another is an inappropriately low foreign exchange value for the currency, in real terms. Many countries have large trade surpluses or low currencies. Sometimes they are appropriate, sometimes not. Usually it is difficult to say for sure.
China’s currency 10 years ago was unusual in that it did seem to meet all the criteria for undervaluation. The real value of the renminbi was estimated to be about 30% below equilibrium in 2005. The Chinese trade surplus reached 7% of GDP in 2007 and the current account surplus reached 10%. But things have changed. The currency appreciated about 30% in real terms between 2006 and 2013, enough that the most recent purchasing power statistics (for 2011), show it in an area that is normal for a country with real income per capita around $10,000. The surpluses as a share of GDP came down too. (The trade surplus is back up again over the last six months due to a fall in China’s import spending, particularly in the energy import bill.)
The criteria that US congressmen focus on is one that has no relevance for economists or for the IMF rules: the bilateral trade balance between China and the US. It is true that China runs a bilateral surplus with the US that is as big as ever. At the same time, however, it runs bilateral deficits with Saudi Arabia, Australia and other exporters of oil and minerals. And with South Korea, from whom it imports components that go into its manufactured exports. Roughly 95% of the value of a “Chinese” smart phone exported to the US is represented by imported inputs; only 5% is Chinese value added. The point isn’t that the trade statistics need to be corrected. The point is, rather, that bilateral trade balances have little meaning.
If I insisted that in return for a haircut my barber must listen to me give an economics lecture, he or she would be unlikely to consider that acceptable payment. I pay my barber in cash, and am in turn paid by Harvard University for my economics lecture. My bilateral balances are not of concern.
Congress requires by law that the US Treasury report to it twice a year whether countries are guilty of manipulation, with the bilateral balance specified as one of the criteria. It would be ironic if China agreed to US demands to allow the exchange rate to be determined freely in the market place and the result were a depreciation of its currency and a gain in the international competitiveness of its exporters.
[A shorter version of this column appeared at Project Syndicate. Comments can be posted there.]