US President Donald Trump, reaffirming long-held convictions, claimed some weeks ago that China and the European Union are ‘manipulating’ their currencies. Now, talk of currency wars and foreign exchange ‘weaponisation’ is in the air.
The president has legitimate gripes on China about, among other things, the theft of intellectual property from foreign firms, the treatment of foreign investment, high tariffs and non-tariff barriers, and subsidisation of state-owned enterprises and industrial policy through the Made in China 2025 initiative.
Currency manipulation and wars sound very exciting. Reality is far more boring. On the renminbi, the president is woefully wide of the mark. China’s current account surplus is falling to under 1% of GDP. The renminbi, hit by capital outflows between early 2015 and the end of 2016, rose sharply against the dollar up to April 2018. The renminbi trade-weighted index rose too. Since then, the renminbi has fallen on both measures, but the depreciation reflects the dollar’s strength across the board. There is little evidence of more than scant Chinese foreign exchange market intervention.
To assess ‘currency manipulation’, a framework is needed. Article IV of the International Monetary Fund’s articles of engagement specifies that countries shall ‘avoid manipulating exchange rates… in order to prevent effective balance of payments adjustment or to gain an unfair competitive advantage over other members.’ US legislation enacted in 2015 and 1988 follows the same approach.
A two-part test is required. What are the basic facts on whether a country is seeking to gain unfair competitive advantage or prevent effective payment adjustment? And, even if the relevant fact pattern is established, ‘in order to’ requires determining the intent of a country’s currency policies.
Establishing the fact pattern is easier than discerning intent. But this too is difficult. Many factors must be weighed. The following framework, which has underpinned US Treasury foreign exchange reports (in which I participated) for well over the past decade – even if the framework has become more quantified in recent years – is a useful way to gauge the fact pattern.
In the mercantilist tradition, a currency manipulating country should have a significant current account surplus. But a current account surplus (as a share of GDP) could also simply reflect an economy’s structure. What one should worry about are ‘excessive’ surpluses (and deficits too). But what is ‘excessive’? One should look at the demographic and institutional features of an economy, and especially the desirability of its economic policies and their impact on national saving and investment, to determine the country’s current account norm. Then, the norm can be compared with the actual current account position. A large gap can be deemed excessive. The IMF annually makes such assessments in its external sector report. The US Treasury in its foreign exchange reports uses a 3% of GDP threshold.
A currency manipulating country might also have an undervalued currency. To judge this, one should look at a country’s real effective exchange rate, not its bilateral dollar rate. Determining ‘undervaluation’ is subjective, and different models yield different results. Further, a rising dollar might mean a surplus country’s currency is falling through no fault of the surplus country. One useful way to judge undervaluation is to assess how much currency appreciation would be needed to erase the gap between the country’s actual current account position and norm. Sometimes impressions can be gleaned by looking at real exchange rate graphs.
A currency manipulating country might also intervene heavily in foreign exchange markets, buying dollars to hold its currency down, resulting in an increase in its foreign reserve holdings. But there might be good reasons to intervene, such as to build up reserves to adequate levels or counter disorderly market conditions. Reserve data can suffer from reporting lags and be blurred by forward market activities or parastatal operations. There are many useful gauges of reserve adequacy to examine – reserves/GDP; reserves/short-term maturing debt; reserves/imports.
One might also look at the structure of a country’s capital controls – are they skewed to prevent inflows from creating pressures for appreciation?
A focus on bilateral balances is silly, even if the US Treasury is required to do so by statute and the president seems obsessed with them. Such an emphasis neglects to consider that certain countries specialise in certain goods and hold comparative advantage in such spheres.
Altogether, determining ‘manipulation’ entails difficult judgments. When one finds a material ‘excessive’ current account surplus, an undervalued currency, and ample and rising reserves, there are good grounds – apart from discerning intent – to suspect a country is pursuing harmful currency practices. For Beijing’s policies, that does not seem to be the case.
On Wednesday I will look at key surplus countries and show that the case now for finding ‘currency manipulation’ is weak – and at its weakest for China.
Mark Sobel is US Chairman of OMFIF. He is a former Deputy Assistant Secretary for International Monetary and Financial Policy at the US Treasury and until earlier this year US representative at the International Monetary Fund.