Tag Archives: renminbi

If China Stops Manipulating, Its Currency Will Depreciate

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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.]

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The Latest on the Dollar’s International Currency Status

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      Most people know that the general trend in the dollar’s role as an international currency has been slowly downward since 1976.   International use of the dollar as a currency in which to hold foreign exchange reserves, to denominate financial transactions, to invoice trade, and to serve as a vehicle for foreign exchange transactions is below where it was during the heyday of the Bretton Woods era (1945-1971). 
But few are aware of what the most recent numbers show.
        It is not hard to think of explanations for the downward trend.   Since the time of the Vietnam War, US budget deficits, money creation, and current account deficits have often been high.  Presumably as a result, the dollar has lost value in terms of other major currencies or in terms of purchasing power over goods.   Meanwhile, the US share of global output has declined.  Most recently, the disturbing willingness of some American congressmen in October to pursue a strategy that would have the Treasury default on legal obligations has led some observers to ask the natural question whether the dollar’s international currency status is now imperiled.
Moreover some EM currencies are joining the list of international currencies for the first time.  Indeed, some analysts have suggested that the Chinese yuan may rival the dollar as the leading international currency by the end of the decade!  (Eichengreen, 2011; and Subramanian, 2011a, 2011b.)
         The trend in the dollar as an international currency has not been uniformly downward, however.  Interestingly, the periods when the public is most concerned about the issue do not coincide well with the periods when the dollar’s share is in fact falling.  By the criteria of international use as a reserve currency among central banks and as vehicle currency in foreign exchange markets, the most rapid declines took place during the intervals 1978-1991 and 2001-2010. (The yen and deutschemark were the rising currencies during the first period, and the euro during the second.) 
In between these two intervals, during the years 1992-2000, there was a clear reversal of the trend, notwithstanding a popular orgy of dollar declinism around the middle of that decade.  Central banks held only an estimated 46% of their foreign exchange reserves in the form of dollars in 1992, but had returned to almost 70% by 2000. 
Subsequently, the long-term downward trend resumed.  According to one estimate, the share in reserves declined from about 70% in 2001 to barely 60% in 2010 (Menzie Chinn).   During the same decade, the dollar’s share in the foreign exchange market also declined:  The currency constituted one side or the other in 90% of foreign exchange trading in 2001, but only 85% in 2010.
      The most recent statistics unexpectedly suggest that the dollar’s standing has again taken apause from its long-term decline.  The International Monetary Fund reports that its share in foreign exchange reserves stopped declining in 2010 and has been flat since then.  If anything, the share is up very slightly thus far in 2013 (COFER, IMF, Sept. 30, 2013).   Similarly, the Bank for International Settlements reported in its recent triennial surveythat the dollar’s share in the world’s foreign exchange markets rose from 85% in 2010 to 87% in 2013 (preliminary global results). That the dollar has been holding up so well comes as a surprise, in light of dysfunctional US fiscal policy.   Or maybe we should no longer be surprised.  After all, when the global financial crisis erupted out of the American sub-prime mortgage mess in 2008, the reaction of global investors was to flee into the United States, not out.  They clearly still regard the US Treasury bill market as the safe haven and the dollar as the top international currency. 
The explanation must be the one that is so often noted: the absence of good alternatives.  In particular, the euro has its own all-to-obvious problems.  Indeed the euro’s share of reserve holdings and its share of foreign exchange transactions have  both fallen by several percentage points over the last three years (reserves from 28% of allocated reserves in 2009 and 26% in 2010, to 24% in the most recent 2013 figures; forex trading from 39% of transactions in 2010 to 33% in 2013).
       What about the vaunted yuan?  According to the IMF statistics, it hasn’t yet broken into the ranks of the top seven currencies in terms of central bank reserve holdings.  The top six are the US dollar and euro, followed by the yen and pound (the latter quietly reclaimed the number three position in 2006 and has been running neck-and-neck with the yen recently), and the Canadian dollar and Australian dollar (also running neck-and-neck). According to the BIS statistics, China’s currency has finally broken into the top ten in forex trading; but its share is only 2.2% of transactions. This is behind the Mexican peso at 2.5%, and still farther behind the Canadian dollar, Australian dollar and Swiss franc.  (See Table 1 and Figures 2 & 3).  
Since 2.2% is much less than China’s share of world trade, it would be more accurate to say that the renminbi is becoming a normal currency than to say that it is becoming an international currency, let alone the top international currency.Despite recent moves by the Chinese government, the yuan  still has a long way to go.  Of the three kinds of attributes that a currency needs to become widely used internationally the yuan  has two – size of the home economy and the ability to hold its value – but still lacks the third:  deep, liquid, open financial markets.
       What might account for the recent stabilization of the dollar’s status?  What do the last three years have in common with the preceding period of temporary reversal, 1992-2000?   Both intervals saw striking improvements in the US budget deficit, both structural and overall.   The federal deficit is now less than half what it was in 2009 or 2010; and the record deficits of the 1980s were converted into record surpluses by the end of the 1990s. Perhaps the fiscal observation is a coincidence.  
It would be foolish to read too much into two historical data points.  It would be even more foolish to believe, just because American politicians have failed to dislodge the US dollar from its number one status over the last forty years, that they could not accomplish the job with another few decades of effort. 
Pound sterling had the top spot in the nineteenth century, only to be surpassed by the dollar in the first half of the twentieth century. It is not an eternal law of nature that the US currency shall always be number one.   The day may come when the dollar too succumbs in its turn.  But that day is not this day.  



Figure 1: The share of the dollar in central banks’ foreign exchange reserves stopped its downward trend in 2010-2013


source: Menzie Chinn (2013), based on IMF’s COFER.



Table 1: The share of the dollar in global foreign exchange trading reversed its downward trend in 2010-2013


Table 1


Source: Bank of International Settlements’ Triennial Central Bank Survey, Sept.2013.


Figures 2 and 3: The share of China’s yuan in foreign exchange trading is rising, but still ranks behind many other currencies

Larger image                                                                Larger image     

Source: Menzie Chinn.  Data from BIS Triennial Central Bank Survey.



Bank for International Settlements, 2013, Triennial Central Bank Survey – Foreign Exchange Turnover in April 2013: preliminary global results, Monetary and Economic Department, September.    

Menzie Chinn, 2013, “What Currencies are Foreign Exchange Reserves Held In?” Econbrowser, Oct. 31.   

Menzie Chinn and J. Frankel, 2007, ““Will the Euro Eventually Surpass the Dollar as Leading International Reserve Currency?” withMenzie Chinn, in G7 Current Account Imbalances: Sustainability and Adjustment,  edited by Richard Clarida (University of Chicago Press: Chicago). 

Barry Eichengreen, 2005, “Sterling’s Past, Dollar’s Future: Historical Perspectives on Reserve Currency Competition,” NBER Working Paper No.11336, May.    

 —— 2011, “The Renminbi as an International Currency.” Journal of Policy Modeling33 (5): 723-730.  

J. Frankel, 1995, “Still the Lingua Franca: The Exaggerated Death of the Dollar,” Foreign Affairs, 74, no. 4, July/August, 9-16  

 ——- 2012, “Internationalization of the RMB and Historical Precedents,” published in Journal of Economic Integration, vol.27, no.3, 329-65.  Summarized in RIETI & Vox.

International Monetary Fund, 2013, Currency Composition of Official Foreign Exchange Reserves (COFER), Sept. 30.   

Arvind Subramanian, 2011a, “Renminbi Rules: The Conditional Imminence of the Reserve Currency Transition.” Working Paper Series No. 11-14 (Washington, D.C.: Peterson Institute for International Economics, September).   

——. 2011b. Eclipse: Living in the Shadow of China’s Economic Dominance (Washington, DC: Peterson Inst. for Int.Econ.).


[This is an extended version of a Project Syndicate op-ed.  Comments can be posted there.]












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Dispatches from the Currency Wars

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The value of the yen has fallen sharply since November, owing to the monetary component of Japan’s efforts to jump-start its economy (“Abenomics”).  Thus the issue of currency wars is expected to feature on the agenda at the G-8’s upcoming summit in Enniskillen, UK, June 17-18.

The phrase “currency wars” is catchy.  But does it have genuine analytical content?   It is another way of saying “competitive devaluation.”  To use the language of IMF Article IV(1) iii, it is what happens when countries are “manipulating exchange rates…to gain an unfair competitive advantage over other members…” To use the language of the 1930s, this manipulation would be a kind of beggar-thy-neighbor policy, with each country seeking to shift net exports toward its own goods at the expense of its neighbors.

Although the phrase “currency wars” has over the last couple of years been applied to expansionary monetary policy by the Fed, Bank of Japan, and other central banks, the concept does not in truth fit very well.  A key point is often missed:   Even the direction of the effect (let alone the magnitude) of one country’s monetary stimulus on its trade balance and hence on the demand for its trading partners’ goods is ambiguous: the expenditure-switching effect when the exchange rate responds is counteracted by the expenditure-increasing effect when the expanding country expands.  Higher income leads to higher imports.  (Chinn, 2013, surveys the effects in the wake of recent QE experience.)

The phrase fits a bit better countries that deliberately intervene in foreign exchange markets to push down the value of their currencies in order to help their trade balances. 

National authorities will and should pursue economic policies that are primarily in their own countries’ interests.There are times when cooperation is fruitful, whether by norms, decisions in multilateral meetings like the G-8 or G-20, or formal institutions like the WTO and IMF.  Indeed, the latter two institutions were conceived by the Allied countries at Bretton Woods NH in July 1944, in an effort to avoid a future repeat of trade wars and currency wars.  This was one month before the same countries met at Dumbarton Oaks in Washington to formulate the United Nations, in an effort to avoid a future repeat of real wars.

But there is little point in even attempting international cooperation if the nature of the spillover effects is not relatively clear and agreed upon.  Everybody agrees for example that pollution spillovers are negative externalities, not positive externalities.   So cooperation means reining in pollution.  Most would probably agree the same about tariffs, the original “beggar-thy-neighbor” policy. But the case is not as clear when it comes to monetary policy.

In the example of fiscal expansion, there may be times when countries can agree that the spillover effects are positive – the locomotive theory, supporting the case for jointly agreed expansion by the largest economies during a time of recession, as at the G7’s Bonn Summit of 1978.  And there may be times when they can agree that the spillover effects are negative – moral hazard among members of a currency area like the eurozone, supporting the case for jointly agreed fiscal deficit rules.   In the case of monetary expansion the nature of the externality is less often clear.

If unemployment is high and inflation low in the United States, it is natural that the Fed will choose an easy monetary policy, particularly via low interest rates.   If the situation is the reverse in Brazil, with the macro-economy overheating (as it was not long ago), it is natural that its central bank will choose a tight monetary policy, particularly via high interest rates.   It is also natural that capital will flow from north to south as a result, that it will in turn appreciate the Brazilian real, and that this will have real effects. 

But that is the beauty of floating exchange rates. Such an exchange rate movement is a sign that the international economic system is working as it should, not the reverse – once one takes as given the difference in cyclical positions of the two countries.  It allows both countries to choose their own appropriate policy settings appropriate to their own circumstances.

Of course the exchange rate movement will help US exporters and hurt those in Brazil, other things equal.   But such “casualties of war” are not even unintended collateral damage.  They are the point of the monetary policies chosen by each of the two countries.  If the goal is to stimulate demand for goods produced in the US and cool off demand for goods produced in Brazil, why shouldn’t the exporters in both countries share in that process, alongside construction and the other sectors that are sensitive to the interest rate via domestic demand in the two respective economies?   (Frankel, 1988.)

More of a dilemma arises if one of the countries had previously been targeting or even fixing the exchange rate.  It could have lots of reasons for having chosen such a regime.  For example, many governments in Latin America finally succeeded in killing off very high inflation rates in the late 1980s and early 1990s only by means of targeted or fixed exchange rates.   Such a country won’t necessarily want to abandon a proven exchange rate regime at the first sign of trouble.

Capital controls and sterilization of reserve flows might help delay the adjustment.  Fiscal policy is another relevant tool.  (Brazil could have reacted to its fears of overheating by reducing its budget deficit, rather than just by controls on capital inflows and appreciation or sterilization.)  But a persistent uni-directional capital flow will eventually force the country with the fixed exchange rate either to allow its exchange rate to adjust or its money supply. 

In the case of China during 2004-2011, this meant a choice between allowing some appreciation of the RMB and allowing an increase in the money supply.   The Chinese did some of both — but more of the latter than the former: the monetary inflow eventually turned inflationary, as expected.

It is true that in recent years an impressively wide array of countries have indicated in some way that they would prefer weaker currencies to stronger ones, as a means to improve their trade balances.  Opinion is often divided internally, however, e.g., within the eurozone or within the US.   The Fed has been attacked domestically for supposedly trying to debase the dollar.  Within the eurozone, Germans tend to want a stronger euro than most other members do.   

It is also true, by definition, that not every country can depreciate at once, nor improve their trade balance at the same time.  This does not necessarily mean that they are guilty of violating any agreements or norms, especially if they have not devalued but merely stuck with a pre-existing exchange rate regime (float, fixed, or band). 

Uncoordinated monetary expansion does not even necessarily leave the world in a worse equilibrium.  It might just give theworld what it world needs.  Barry Eichengreen and Jeffrey Sachs (1985, 1986) persuasively argued this for the 1930s, the opposite of the conventional wisdom regarding beggar-thy-neighbor competitive devaluations.  To the extent that every country devalued against gold, although they could by definition not all succeed in improving their trade balance, they could and did succeed in raising the price of gold and thereby increasing the real value of the global money supply, which is what a world in Depression needed. The same applies today (Eichengreen, 2013): US monetary expansion has contributed to global monetary expansion at a time when it was needed on average.

The specific merits of the “currency war” interpretation vary from country to country.

The US was the target of the man who originally launched the missile, Brazilian Minister Guido Mantega, in September 2010.    The currency wars language initially came as Brazil’s response to American efforts to enlist it and other trade competitors of China in a campaign for a stronger RMB.  (As side-kick Tonto famously said to the Lone Ranger, “What do you mean we, white man?”)   But the accusation is especially misplaced against a country like the United States:  the US authorities have not intervened in the foreign exchange market nor talked down the dollar. Depreciation of the dollar is probably not even toward the top of the list of the effects that the Fed had in mind when deciding to undertake Quantitative Easing, though mind-reading is difficult and the right answer must vary across members of the FOMC. 

True, the usual channel of monetary stimulus, via the fed funds rate and other short-term interest rates, is all-but-ended by the Zero Lower Bound.  But that still leaves effects on longer term and riskier securities, the credit channel, expectations regarding inflation, equity prices, real estate prices, and so on. It doesn’t have to be the currency depreciation channel.  

Japan comes a little closer than the United States to meriting the status of currency warrior, in that members of the new Abe government were initially foolish enough as to mention yen depreciation as an explicit goal.

China qualifies in one important respect: the RMB was undervalued by most measures from 2004 to 2009 (less so, by now).   But countries have a right to opt for a fixed exchange rate regime.  China was continuing a regime that had previously been in place, which does not sound like “manipulation.”   True, appreciation was probably in China’s interest.  It would have been reasonable, beginning in 2004, for those worried about current account imbalances to propose that China voluntarily allow some appreciation as part of a deal voluntarily agreed among sovereign states — in exchange, for example, for the US putting its fiscal house in order.  But this is different from charging Beijing with having violated international norms or rules and from threatening retaliation (e.g., by tariffs, which are a violation of WTO rules).

Indeed, very few of the countries accused of participating in the currency wars have undertaken discrete devaluations in recent years or otherwise acted to weaken their currencies by switching exchange rate regimes.    These are the sort of deliberate policy changes connoted by a phrase like “manipulation,” whether judged “unfair” or otherwise.

Switzerland perhaps comes the closest to meeting the definition.  But the Swiss franc is strong, even at the rate that was newly set September 2011.  It is hard to prove the case for unfair undervaluation.

Countries have enough serious disputes as it is, without creating unnecessary ones.


[Comments can be posted at the Project Syndicate blog site.  The blog is an expanded version of a Project Syndicate op-ed.   See also video or slides of a panel on “Printing pressure: Global currency war,” held at the American Enterprise Institute, March 18, 2013: Jeff Frankel, Anne Krueger, Rakesh Mohan, and John Makin, organized by Desmond Lachman. ]


    Chinn, Menzie, 2013, “Global Spillovers and Domestic Monetary Policy: The Impacts on Exchange Rates and Other Asset Prices,” prepared for the 12th BIS annual conference, 20-21 June, Luzerne.         
     Eichengreen, Barry, 2013, “Currency War or International Policy Coordination,” forthcoming in Journal of Policy Modeling. Bellagio Group, Tokyo, January.
    Eichengreen, Barry and Jeffrey Sachs, 1985, “Exchange Rates and Economic Recovery in the 1930s,” Journal of Economic History 49, pp. 924-946.
    Eichengreen, Barry and Jeffrey Sachs, 1986, “Competitive Devaluation and the Great Depression: A Theoretical Reassessment,” Economics Letters 22, pp. 67-72.
    Frankel, Jeffrey, 1988, “The Desirability of Currency Appreciation Given a Contractionary Monetary Policy and Concave Supply Relationships,” Journal of International Economic Integration 3, no.1, spring, pp.32-52.  NBER WP No.1110.
    Frankel, Jeffrey, 2006,  “On the Yuan: The Choice Between Adjustment Under a Fixed Exchange Rate and Adjustment under a Flexible Rate,” in Understanding the Chinese Economy, edited by Gerhard Illing (CESifo Economic Studies, Munich)
     Frankel, Jeffrey, 2010, “The Renminbi Since 2005,” in The US-Sino Currency Dispute: New Insights from Economics, Politics and Law, edited by Simon Evenett (Centre for Economic Policy Research: London), April, pp.51-60.
     Frankel, Jeffrey, and Katharine Rockett, 1988,”International Macroeconomic Policy Coordination When Policy-Makers Do Not Agree On the Model,” American Economic Review 78, no. 3, June, pp. 318-340. NBER WP 2059.

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