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Analysis
US-China deal raises critical questions

US-China deal raises critical questions

Conditions for currency stability are ripe

by Mark Sobel in Washington

Tue 26 Feb 2019

Washington has announced, following persistent pressure, that the US and China have reached an understanding on a stable renminbi as part of a possible US-China trade deal.  

This should come as no surprise. The US administration was fretting about renminbi depreciation as the dollar surged in 2018. President Trump has long made unwarranted complaints against Chinese currency 'manipulation'. One can only imagine how he would react if he agreed not to raise tariffs on China and then the renminbi fell, boosting Chinese competitiveness, and worse yet for him, widening the US bilateral deficit.

Beijing clearly wants a trade deal. It has in past years sought currency stability, albeit mainly against a trade-weighted basket.

The dollar rose sharply in 2018 against emerging market currencies. This happened as the renminbi fell to its lowest level in a decade, sending shivers up Chinese authorities' backs, concerned about a possible destabilising surge in capital outflow.

The conditions for stability are ripe. Trump's rhetoric on China trade has softened, perhaps to limit fallout in the US stock market. The Fed signaled its 'pause' and US yields came down. China's aggressive accommodation policies of recent months may be showing signs of stabilising the economy. In short, there is likely to be an agreement on currency stability if there is a trade deal. However, such an agreement raises critical questions and the details – which have yet to be revealed – are crucial.

First, the parties must determine whether the deal would be hortatory or binding. The G20 in February 2013 agreed on currency understandings, oft-repeated since then, including by China. These entail moving toward more flexibility, avoiding persistent misalignments, refraining from competitive devaluations and not targeting exchange rates for competitive purposes. These read like guidelines. One would expect that the US negotiating team would seek more than that.

Second, many analysts have pointed out that 'stability' has various meanings. China has in recent years sought to promote renminbi stability against a currency basket. Stability against the dollar is quite different. China pursued renminbi stability against the dollar before the 2008 financial crisis; that was tantamount to importing Fed policy, which made little sense for China. Of course, the Trump administration will only care about renminbi stability against the dollar.

Third, the renminbi-dollar rate can fluctuate. Since China cannot be responsible for US policy developments, it is unclear how a currency deal would take account of that.

Fourth, if the deal is more than exhortative, policy-makers must find a way enforce it. The US and China must decide whether their understanding on a renminbi-dollar currency zone will be implicit or explicit, or if it will be a one-sided peg. In any case, the two parties need to delineate in which circumstances the zone could be breached or altered. It remains to be seen whether Beijing will commit to intervene, or if it will alter its monetary policy, regardless of domestic circumstances. Another unknown is what policy commitments Washington would make to uphold renminbi-dollar stability if US developments are the cause of a depreciating renminbi.

One might ask whether such a currency stability understanding is sensible public policy. For Trump's team and given its rhetoric on 'manipulation' and focus on bilateral balances, it makes sense. Economists dismiss the relevance of bilateral balances, but that is of scant import to the administration. There is no reasonable case for Chinese 'manipulation'. Further, the US has long called on China to promote greater currency flexibility – but apparently that applies only in the case of an appreciating renminbi against the dollar.

Beijing has sought to implement a more modern monetary policy framework, promote greater currency flexibility, and avoid intervention in foreign exchange markets. Therefore, a deal stabilising its currency against the dollar runs counter to the policy orientation of the People's Bank of China.

A currency understanding is likely to be struck as part of any trade deal. The near-term conditions for maintaining renminbi stability against the dollar are broadly favorable. China has policy tools at its disposal to support such a deal. And, given the country's aversion to its currency depreciating against the dollar in 2018, it would not appear to be a big Chinese give. The pertinent questions are what will be the contours of the deal and will it have teeth. Whether such a deal is good policy is a different matter. In the long-term, especially as China's current account surplus dwindles away, and capital is bottled up but seeking to leave the country, keeping the renminbi stable against the dollar may be a more difficult undertaking.

Mark Sobel is US Chairman at OMFIF.

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