Treasury navigates shoals of administration

Foreign exchange report and US politics

The latest instalment of the US Treasury’s semi-annual foreign exchange report is certainly more interesting than previous iterations, for better or worse.

Unsurprisingly, China is front and centre, with the report launching into tough rhetoric. Washington is right to decry the scale of Chinese industrial policies and subsidies. The report analyses and castigates the large Chinese bilateral surplus with the US. It criticises harshly the renminbi as undervalued against the dollar, pointing to the Chinese currency’s depreciation of 8% over the past year.

But there is a disconnect between the summary’s tone and the sections on international economics and China. In drier analysis, the text observes that the dollar is up across the board, and has made more gains than the renminbi against emerging market currencies. Dollar firmness is ascribed to ‘overperformance’ of the US economy.

The report acknowledges the International Monetary Fund’s work on the renminbi being valued fairly and states the real effective renminbi has been flat. It notes that China is not intervening, save to support its currency, and that capital outflow is being constrained. The report discusses the broadly neutral current account.

Economists dismiss the relevance of bilateral balances. If the dollar is up owing to US economic overperformance, perhaps dollar ‘overvaluation’ is causing renminbi ‘undervaluation’. If that is the case, how can US overperformance be turned into a harmful Chinese currency practice? The Treasury could analyse usefully the extent to which China’s role in global value chains means exports to the US are attributed to China, even if much value added comes from southeast Asia.

The Treasury modified the criteria for its enhanced analysis, expanding coverage of major trading partners from to 21 from 12. This is welcome. As noted in prior OMFIF work, past reports failed to capture several southeast Asian countries with a large collective surplus and at times questionable currency practices.

But the report cut the material current account surplus threshold to 2% from 3% of GDP. Countries’ current account norms vary, depending on their structure and circumstances. For a cross-country analysis, the report needs to make a discretionary assumption as a benchmark.

In implementing the 2015 law for the report’s enhanced analysis, the Treasury chose 3%, arguing it was ‘robust’. The 3% figure was buttressed by the work of Fred Bergsten and Joe Gagnon of the Peterson Institute for International Economics, the Washington-based thinktank. Little rationale is offered for changing to 2%, other than it brings in more of the global surpluses.

But the 2% threshold may be too low, especially for smaller countries. It may pick up more countries, perhaps controversially. Some have structural reasons for a larger than 2% surplus. Commodity price swings may push countries above or below a modest threshold. So could demand compression. If the US current account deficit is rising, its counterpart will be found in higher surpluses elsewhere.

With regard to the Treasury’s watch list, it weighs equally and applies mechanistically three criteria: whether the top 21 US trading partners have significant bilateral surpluses with the US, material current account surpluses, and ARE engaged in persistent one-sided foreign exchange intervention. This has led to perverse outcomes, for example India’s past inclusion despite its current account deficit.

The bilateral balance component should be downplayed as a matter of good economics, but the current US administration is unlikely to concur.

The inclusion in the list of Italy and Ireland is incongruous. As the paper itself acknowledges, once multinational corporate activity is accounted for in Ireland, the case for inclusion disappears nearly. Italy’s current account surplus is helpful in reducing country risk, given the country’s large bond market and high debt.

There has been much discussion about designating Vietnam as a ‘manipulator’. IMF data show that Vietnam’s current account surplus has hovered around 3% of GDP for several years. Even if Vietnam has at times intervened to build up reserves, its reserves-to-months-of-imports ratio is low, differentiating it from a country with large or ‘excess’ reserves.

If Washington is content to see global value chains move out of China, it should expect an increase in Vietnam’s surplus. To have modified a criterion which picked up Vietnam, only to label it a currency manipulator straight away – the first designation in more than 20 years – would have been precipitous and ill-conceived. Treasury was right not to designate Vietnam.

The Treasury report reads as if Treasury managed to navigate the shoals of the administration for another six months and steer clear of a ‘currency manipulator’ designation. Unfortunately, and perhaps inevitably, it had more of a political feel to it than in the past.

Mark Sobel is US Chairman of OMFIF.

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