US Treasury Secretary Janet Yellen has made it clear that harmful currency practices remain a problem that the Treasury will tackle head on. In the first foreign exchange report released under Yellen, the Treasury appears to be calling for a welcome timeout on ‘manipulation’ designations, while keeping this option open for the future.

In contrast with FXRs from Donald Trump’s administration, this report is less bellicose, emphasises multilateralism over bilateralism and shows greater appreciation for the nuances and diplomacy of international finance. It allows the country analysis and heft of Treasury’s civil service to stand out and enhances the FXR’s credibility. But problems remain.

The key distinction between this and the last report is that the Treasury does not designate any country as a manipulator. This is despite Switzerland and Vietnam being designated as such under Trump and Taiwan joining them in meeting the three criteria for designation: excessively large bilateral surplus, current account surplus and foreign exchange dollar purchases.

‘Manipulation’ findings are made pursuant to the 1988 Omnibus Trade and Competitiveness Act. Under the statute, manipulation must be ‘for purposes of preventing effective balance of payments adjustment or gaining unfair competitive advantage in international trade’.

The lack of designations in this report is reasonable. However, the Treasury does not explain its rationale well, though it seemingly points to the impact of the pandemic in distorting the external positions of countries. Nor does the Treasury explain its worldview on designations – the law states that the Treasury must pursue manipulation. But have designations been effective or is a rethink needed?

The report also doesn’t forthrightly discuss how US policies impact global imbalances. But strong US fiscal stimulus is boosting US performance relative to others, raising the US current account deficit and others’ surpluses, while lifting US interest rates and often depressing others’ currencies.

It could be that the Treasury wishes to give diplomacy a chance. Trump’s team designated China, Vietnam and Switzerland as manipulators, but with little to no apparent impact. This FXR places great emphasis on engagement with Switzerland (which shouldn’t have been designated to start with), Vietnam and Taiwan, the three countries slated for enhanced engagement. It appears the Treasury wishes to intensify discussions with them to better understand their currency policies and practices. The Treasury also doesn’t preclude future designations.

The report offers useful nuances. In past years, Treasury staff pushed others on foreign exchange transparency, especially intervention. Despite important gains, this FXR more vigorously hits that theme, especially on opaque Chinese foreign exchange intervention data and practices.

Trump’s team emphasised bilateral balances. Yet, economists often dismiss their relevance. Looking at them is stipulated by law. But on the FXR’s key summary table (page 56 of the report), bilateral balances are the third trigger, no longer the first. They are less prominently highlighted in country pages. Hopefully, this is the start of a relative de-emphasis.

Disappointingly, this FXR sticks with existing thresholds, though the possibility for change remains. Despite the bilateral balance nuance, this FXR adheres to its existing enhanced analysis thresholds and weights the three criteria equally. The material current account surplus threshold remains at 2% of gross domestic product, which the Trump administration cut from 3% to pick up more countries. The 2% figure is too low and potentially noisy.

The FXR ‘monitoring list’ still struggles to strike a sound balance between quantitative and qualitative analysis. The Treasury maintains its ‘monitoring’ list of countries. That is fine. But the mechanistic approach of including those tripping two of the three criteria and judging them over a one-year period results in peculiar findings.

Thailand has long had enormous current account surpluses and intervention. Despite a much lower 2020 current account surplus as the pandemic brought tourism to a standstill, it remains well above 2%. Large intervention continues, but fell in 2020 to 1.9% of GDP, reflecting fewer dollar purchases due to the lower current account surplus and perhaps a gaming of the thresholds. The threshold creates a steep cliff. Yet, Thailand is ripe for enhanced engagement.

China remains on the list, despite only tripping one criterion.

India and Mexico habitually run current account deficits, though both had pandemic-related current account surpluses in 2020. India’s was just over 1%, yet due to the other two criteria oddly finds itself on the list. Mexico’s inclusion is more awkward: the peso floats; Mexico only intervenes rarely, as in 2020, to keep the peso from falling further; and the shift to surplus reflects Mexico’s steep 2020 recession, Covid-19 and proximity to the US.

The euro area doesn’t fit well into the Treasury’s framework. The euro floats and individual members don’t have their own currencies. Still, each member has its own real effective exchange rate and its policies impact its saving/investment imbalance. Yet Germany’s current account surplus remains sky high – the largest in the world – and its excess saving is the largest distortion to the global distribution of demand. This is a point that the Treasury needs to continue hammering. The presence of Italy and Ireland looks odd.

The FXR concludes: ‘As the global economy continues to stabilize, it is critical that key economies adopt policies that allow for a narrowing of excessive surpluses and deficits.’ Let’s hope that the US also takes this wonderful admonition to heart.

Mark Sobel is US Chairman of OMFIF.