US-China currency diplomacy
The inside story: 2003-present
By Mark Sobel, US Chairman, OMFIF
China’s currency practices are a source of much debate, and the subject of frequent attacks and manipulation accusations by US President Donald Trump. Yet the controversy surrounding Chinese exchange rate policy is nothing new. Already, in the early 2000s, Beijing’s currency practices were a heated topic of discussion, globally and especially in the US. At the time, this issue understandably took on considerable emotion as harmful Chinese currency practices were fairly and widely seen as leading to the loss of many manufacturing jobs.
Between 2003-16, the US Treasury Department undertook a process of extensive engagement on currency diplomacy with China’s leadership and financial authorities. Treasury’s focus on the issue was singular and laser-like. No effort was spared. Though Treasury’s work has been much maligned by the public, US Congress, many businesses and commentators, with the benefit of hindsight it can be seen broadly speaking as having achieved important successes.
The Treasury over many years was consistently berated for not designating China for currency ‘manipulation’ in its semi-annual foreign exchange reports. Legislative proposals abounded, with many provisions aimed at forcing or tying Treasury’s hands and questioning its efforts.
Legitimate questions were raised – especially ahead of the 2008 financial crisis – about whether China should have been designated, given the large undervaluation of the renminbi, the country’s massive current account surpluses and the enormous and excessive build-up in Chinese reserves. These problems persisted for several years following the crisis.
China is a sovereign country. It faced its own internal economic policy constraints as it underwent massive transformation. How and when China moved on the exchange rate was fundamentally relevant to the Chinese growth model, economic structures and growth outcomes. Moving was a sovereign Chinese decision, ultimately up to China’s leadership. Beijing had to perceive it as in its own self-interest to do so.
US voices paid little attention to these hindrances, often simply arguing that China was behaving malevolently. US financial diplomacy, however, had to navigate the shoals of the realities on the ground in China.
From 2003-16, Treasury Secretaries John Snow, Henry Paulson, Tim Geithner, Jack Lew and their teams pursued a consistent course to address Chinese currency policy. That course emphasised extensive engagement with the Chinese authorities, as well as close dialogue at home, especially with Congress. They had to learn about and understand Chinese exchange rate perspectives in the broader context of China’s economy and politics. They presented credible arguments to Chinese officials for changing exchange rate policy. Though ultimately, Beijing was the main mover and shaker in changing its ways, Treasury’s engagement contributed to China’s policy shift.
The nuances of policy and argumentation evolved. But the adherence to the basic strategy of diplomatic engagement was steadfast. In balancing Chinese developments and domestic pressures, Treasury officials did their utmost to steer clear of protectionist legislation.
Treasury undoubtedly made mistakes in the process. But contrary to the generally prevailing public narrative and conventional wisdom, the currency diplomacy of 2003-16 helped secure meaningful results. It is broadly speaking a success story. 
The paper below examines in detail Treasury’s currency diplomacy from 2003-16. It discusses American and Chinese perspectives. It includes a discussion of why the policy in the end can be seen as a ‘success’, as well as why the Trump administration’s renminbi policy represents a major departure from the 2003-16 diplomacy.
 The author was US Treasury deputy assistant secretary for international monetary and financial policy for almost the entirety of the 2003-16 period, participating in drafting the foreign exchange report and diplomatic discussions with China, the IMF, and the G7/20. Detailed books have been written about US financial diplomacy toward China. This paper intentionally takes a broad approach to the major themes of the period. Its value added comes because of the vantage point from a Treasury insider.
 This paper generally cites Treasury secretaries and under-secretaries. But the efforts also reflected the hard work of many smart and talented individuals on Treasury staff. All of the names could not be replicated. At pain of offending some who are excluded, the author would thank and cite in particular Robert Dohner, David Loevinger, David Dollar, Robert Kaproth, Mat Haarsager and John Weeks.
The US perspective
The US debate about Chinese currency practices understandably was largely predicated on US domestic concerns and perspectives.
Americans in the early 2000s saw China’s current account surplus surging, hitting a whopping 10% of GDP in 2007. Its reserves soared in this period, ultimately hitting a massive $4tn in 2013-14. The renminbi was seen – correctly – as significantly undervalued. Many manufacturing jobs were hollowed out. Whether due to globalisation, technological change or China – probably some combination of all three – Americans heavily blamed China. Many assumed China was acting in a malevolent fashion. Congressional pressures intensified.
The Treasury engaged heavily Chinese leaders and officials to effect change in China’s exchange rate policies, recognising that China is a sovereign country and would only change its policies on its own terms. China began hesitantly to allow currency appreciation in the mid-2000s, and then picked up the pace before the 2008 financial crisis.
To help achieve this outcome, bilateral and multilateral engagement was continuous and a priority for President George W. Bush and his cabinet. Treasury marshalled its best economic arguments. The administration pushed back on what it perceived to be protectionist congressional currency legislation.
During the financial crisis, the American public’s focus on the renminbi abated. Afterwards, China’s current account surplus came down sharply and the renminbi appreciated considerably against the dollar. But with rising reserves and a still hefty Chinese trade surplus both in aggregate terms and with the US, domestic pressures to act against China surged anew.
In 2014-16, China was racked by growth fears, financial market woes, and massive capital outflows. It drew down $1tn in reserves to keep the renminbi from further falling. But American public perspectives changed little, complicating Treasury’s engagement and efforts to explain what was happening and fend off various pieces of legislation.
In 2017, President Donald Trump came to office, protesting China’s bilateral surpluses with the US, and saw trade in general – but especially with China – as unfairly stacked against the US. This was often ascribed to Chinese currency manipulation, even though key criteria for doing so – a small current account surplus and no intervention – pointed to the opposite conclusion. The International Monetary Fund judged the renminbi as fairly valued. Instead, the administration focused on the US bilateral deficit with China. It suspended formal engagement with Beijing.
The US debate from 2003-20 largely ignored consideration of Chinese developments and perspectives, which were highly relevant for outcomes.
China’s perspective on the renminbi was driven by myriad factors. External voices may weigh on decision-making, but those voices are one among many, in competition with domestic factions and public opinion. China is undergoing a profound and rapid transition from central planning to a more market-oriented system in which the state still exerts large sway. Chinese leaders place a huge premium on domestic stability.
Beijing questioned throughout whether the US was addressing its own issues, and blaming China for ills or global forces such as technological change and globalisation that were not simply attributable to China. Chinese officials’ views of the US were significantly hurt and coloured by the fallout from the financial crisis.
The People’s Bank of China is unlike the Federal Reserve and central banks in most major advanced economies. It is not ‘independent’. The PBoC takes orders from the leadership and State Council, and has to work with the National Development and Reform Commission, among others, in setting policy.
Well into the 1980s, the central bank housed the major Chinese state-owned banks. Throughout most of the 1990s, the central bank was simply responsible for ensuring allocation of a credit plan.
The trappings of a more modern central bank policy began to evolve in the 1990s. China pegged its currency and held it steady during the 1997-98 Asian financial crisis, while the country lost competitiveness to its rivals, receiving global praise for its contribution to stability.
Reform gathered steam in the early 2000s, particularly with the appointment in 2002 of Zhou Xiaochuan as governor of the People’s Bank of China, who started bringing in internationally trained bankers and economists – the so-called Sea Turtles.
Economic management at the time still relied on preferential lending, a credit plan, window guidance and capital and price controls. The exchange rate remained fixed. Growth was the priority and credit would be furnished to meet growth targets.
China opens up slowly
Only over the course of 2000-09 did China begin to liberalise interest rates, develop more modern money market instruments, and use open market operations to help transmit monetary policy and manage inflation.
The central bank realised as early as 2003 that foreign exchange intervention was creating an unwarranted build-up in liquidity, potentially complicating efforts to control inflation. The PBoC sterilised somewhat successfully the liquidity build-up earlier in the decade. But doing so became more difficult in the latter half, with attendant implications for credit expansion and prices. In the years just prior to the 2008 financial crisis, the PBoC was frantically raising required reserves and beginning the process of liberalising bank deposit and lending rates to control credit growth and surging inflation.
The central bank recognised throughout the decade that appreciation of the renminbi would help alleviate these problems as well as impact the balance between domestic and external production. Its policy, particularly after the 2005 revaluation, was to move to move to greater market orientation – ‘a managed float based on supply and demand with reference to a basket’.
As further recognised during this period by Yi Gang, now governor of the PBoC, over the long term, China was bound to have a floating exchange rate and free capital flow. But in the meantime, it needed to develop the instruments for foreign exchange trading. Exchange rate adjustment was integral to rebalancing the relative price of tradable and non-tradable goods. Too rapid a movement could disrupt economic activity, and structural adjustment was paramount to shift the economy’s orientation toward greater domestic demand and help achieve internal and external balance.
Yi Gang’s conclusion was that the US needed to exhibit patience, a virtue in short supply in Washington.
The PBoC’s efforts to move toward a more market-oriented and appreciated renminbi faced massive challenges. The central bank was up against major domestic forces. With growth relying heavily on export demand, many opposed renminbi appreciation. There were deep concerns about a higher renminbi bankrupting low-value added exporters and creating social disruption. The NDRC and commerce ministry disagreed with renminbi revaluation or appreciation. Parts of public opinion felt the US views on Chinese currency policy were really aimed at containing China.
Meanwhile, US engagement and pressure continued steadfastly, and in some ways backed the PBoC’s aims for economic liberalisation.
All of this landed in the laps of China’s leadership, which had limited understanding of market economics. The leaders were in principle inclined to implement gradual market-oriented reforms so long as domestic stability was anchored. They were slow and hesitant to make exchange rate reforms, as seen in the years of external pressure needed to bring about even the modest 2005 revaluation.
Against a stable domestic backdrop, continued US engagement and surging inflation, the PBoC was allowed to undertake considerable exchange rate appreciation between mid-2006 and mid-2008, before China re-pegged the exchange rate against the dollar as the financial crisis unfolded.
Coming out of the crisis, Chinese leaders understood that the economy had become too large to rely simply on external demand for growth. Doing so was not only controversial overseas, it was risky for China itself. China needed to rely more on domestic demand and consumption, and move up the value chain to power growth.
But with resumed post-crisis current account surpluses and foreign direct investment inflows, China again began building up reserves, despite continued renminbi appreciation versus the dollar.
Rising renminbi prompts policy shift
The authorities shifted currency policy anew in early 2014 to weaken the renminbi, to signal they would not tolerate a one-way currency bet, and minimise losses in external competitiveness. By 2015, China was slowing the renminbi’s decline against the dollar, drawing down on its excessive reserves of almost $4tn.
In August 2015, China changed how it set its currency reference rate, surprising markets and sending the renminbi down. While the PBoC continued to cushion the renminbi’s decline through 2016, at which time reserves fell toward $3tn, it concluded that it wished to get away from intervention altogether.
But capital outflow had shot up in 2014-16. To foster overall currency stability and avoid further reserve drawdowns amid China’s diminished current account surpluses and falling FDI inflows, increasingly tight capital outflow controls were needed.
As a result, beginning around end-2016, current account inflows were balanced out by capital outflow. Intervention to cushion the renminbi’s fall came to an end and has since been dormant. The exchange rate regime could be seen as a managed float, and the trade-weighted renminbi has been generally stable. The central bank remains focused on managing inflation through a more modern monetary policy framework.
But the PBoC is still not independent, even if it is now a more powerful actor inside China. While it aims to become a more ‘normal’ central bank, it has much farther to go. It needs to enhance the functioning of its monetary policy instruments, liberalise interest rates in reality, and develop capital markets to a far greater extent. Eventually and slowly, the bank must open the country’s capital account with the aim of achieving convertibility, and overcome the weaknesses of Chinese commercial banks and the enormous financials risks stemming from a highly overleveraged economy.
Even if symbolic and hortatory, Chinese authorities began to talk about the renminbi assuming an international role and deemphasising the dollar’s dominant systemic role. The currency’s 2015 entry into the IMF’s special drawing rights basket epitomised this thrust of Chinese policy, though there has been little headway.
 See Yi Gang, Cato Journal, Volume 28; #2; Spring/Summer 2008.
US financial diplomacy from mid-2003 to now
Treasury’s currency diplomacy with China has followed a winding path. From mid-2003-16, it followed a continuous policy of strong bilateral and multilateral engagement. Treasury recognised that exchange rate reform was a sovereign Chinese decision, put forward the best arguments for change in Chinese exchange rate policies, and worked at home with Congress and the public. This strategy delivered results far too slowly and Treasury undoubtedly made errors along the way. Still, it achieved progress and from the hindsight of today’s vantage point can be broadly viewed as a success story. The same cannot be said of the Trump administration’s post-2016 renminbi diplomacy.
2003-06: China hits the global scene, furore erupts, engagement starts
China unified its dual exchange rates in 1994 and adopted a fixed exchange rate. As the country entered the Asian financial crisis in the late 1990s, its exchange rate was pegged at Rmb8.28 per dollar. China maintained the peg throughout the crisis, while its neighbours’ currencies fell and China lost considerable competitiveness. It received much international praise for its contribution to global financial stability.
Given the central planning background of China’s leaders, familiarity with and understanding of market economics was sorely lacking. In managing a complex transition in a country of more than 1bn people, exchange rate issues hardly featured on leaders’ radars.
But with China’s World Trade Organisation entry, the 2000s ushered in a period of rising Chinese global economic interdependence, soaring Chinese trade and current account surpluses, and a surge in the bilateral surplus with the US. Reserves rose as China absorbed current account and foreign direct investment inflows through foreign exchange intervention. The renminbi was clearly undervalued.
These developments set off a political firestorm in the US. Many industries blamed Chinese currency practices for declining manufacturing jobs. Senator Chuck Schumer in 2003 for the first time put forward legislation to impose a 27.5% duty on Chinese imports.
John Snow became Secretary of the Treasury in early 2003, and by mid-year was fully seized with this maelstrom. The broad outlines of the strategy he and his team developed to tackle Chinese currency issues, which his successors followed, rested on strong substantive argumentation in support of greater flexibility and extensive diplomatic engagement – with China, multilaterally, and at home.
Snow’s tenure encapsulated two periods in Chinese foreign exchange policy – the stretch leading up to the 2.1% revaluation of the renminbi against the dollar in July 2005, and a subsequent time of limited movement and inadequate progress while imbalances worsened.
In essence, the US side saw early on that to progress, China had to recognise that reforming the exchange rate regime was in its own self-interest. Further, Treasury needed to manage domestic US strains on China. Some pressure could helpfully prod China’s leadership, but too much would likely backfire and lead to defensiveness in Beijing.
Beyond encouraging a stronger renminbi, Treasury’s argumentation at first emphasised heavily China’s need to adopt market mechanisms that would put in place building blocks for a move to greater flexibility. This was seen as entailing, for example, the development of hedging instruments, supervision of currency risks, work on addressing non-performing loans and credit analysis, as well as reserve management.
Over time, the argumentation was enhanced, putting forward the case for renminbi appreciation and flexibility as a requisite for internal and external rebalancing of the Chinese economy and its growth model. Treasury ultimately distilled this message into a three-part plan.
On exchange rate policy, Treasury stressed the need for China to move more rapidly to a more market-based, flexible exchange rate regime. Greater exchange rate flexibility was viewed as strengthening the ability of Chinese monetary policy to help assure sustained growth and control inflation. Along with interest rate liberalisation, flexibility would help provide for more efficient financial intermediation. In short, a strong and more flexible renminbi would help China achieve more balanced and sustainable growth, reduce global imbalances and promote greater flexibility in Asia.
On domestic rebalancing, China should boost domestic demand to lessen its reliance on external demand, moving away from a high saving society and toward greater consumption and services. Lessening high saving over time would require building up China’s social safety net.
Financial sector reform would also be crucial. With strengthened balance sheets, banks could offer better financial services, which would allow Chinese citizens to earn higher rates of return, and better meet their consumption and financial security needs.
The argumentation and the increasing tensions surrounding Chinese currency politics were evident in Treasury’s foreign exchange reports. The early 2003 iteration made little mention of Chinese exchange rate issues. But by the autumn, the report underscored that China’s policies were ‘not appropriate for a major economy’ and began to advance the intellectual case for flexibility. The sharpness of Treasury’s findings picked up noticeably in 2004, amid much public attention on the question of designating China for currency manipulation. Those findings also highlighted the Department’s extensive engagement with China to create an infrastructure for currency flexibility.
Treasury’s frustration at the lack of Chinese movement was readily evident in a May 2005 report. This branded Chinese currency policy a ‘substantial distortion’ to world markets and a challenge to the global economy. It noted that China already had completed significant preparations for flexibility.
Beijing revalued the renminbi by 2.1% in July 2005 to Rmb8.11 from Rmb 8.28 per dollar. It stated it would begin allowing the renminbi to fluctuate, in a narrow band against a basket of currencies. Treasury welcomed this move as an initial step. But the rate was little changed against the dollar over the subsequent year, only rising above Rmb8 in June 2006, a move of slightly more than 1% from July 2005.
China’s surpluses and reserves continued to soar and US complaints heated up. Congress put forward further draft legislation aimed at imposing import duties on China and finding currency undervaluation a countervailable subsidy.
Against this background, the subsequent foreign exchange reports through mid-2006 rebuked China for the constricted operation of the new system and argued the country was moving toward greater flexibility far too slowly and hesitantly. The reports expressed alarm about the continued persistence and build-up of distortions, and urged much faster movement.
Engagement with China was extensive and non-stop throughout the period. It was a time for developing a relationship with Chinese financial authorities and a dialogue with the leadership on currency matters.
Secretary Snow visited Beijing in September 2003 on his way to an Asia Pacific Economic Co-operation ministerial meeting. He convened with Chinese Finance Minister Xiang Huaicheng, PBoC Governor Zhou and Premier Wen Jiabao to make the case for flexibility. That trip laid the foundation for the creation in October 2003 of a technical co-operation programme between the US and China to facilitate exchanges between financial experts on such topics as financial and capital market development, supervision and foreign exchange management, with a view to promoting Chinese financial reform and opening up.
At the same time, led by Treasury Under Secretary John Taylor, G7 finance deputies met with their Chinese counterparts on the margins of the IMF/World Bank Annual Meetings in Dubai. G7 ministers signed off on the principle of flexibility for large economies. Snow appointed a senior representative to act as an emissary in Beijing.
Treasury officials met repeatedly with Chinese officials in 2004-05. The US-China joint economic committee met in September 2004, and China reiterated its commitment to move to a market-based flexible exchange rate. Wen echoed this commitment, as did Zhou. G7 ministers in October 2004 met with Chinese counterparts for the first time.
Throughout, there were meetings with Congressional staff and representatives, and industry officials. Senior Treasury officials testified often.
By mid-2006, Treasury had begun to develop deep contacts with China’s leadership and financial authorities. It marshalled pressure and put forward a substantive case for China to change its foreign exchange policy on the basis of Chinese self-interest. Treasury also worked to multilateralise the issue, and responded to Capitol Hill’s strong complaints – even if not to the satisfaction of Congress. Beijing committed to support greater flexibility and in July 2005 had at least moved off of its decade-old renminbi peg.
2006-09: Renminbi rises amid US manipulation outcry
Hank Paulson assumed the Treasury’s reins in mid-2006. The renminbi had scantly moved since the previous year. China’s current account surpluses continued to soar, surpassing 8% of GDP and moving higher. Foreign exchange reserves were also rising, heading above an excessive $1tn. The US bilateral goods trade deficit with China was more than $200bn per annum and also surging. Domestic attacks on Chinese currency policy were understandably mounting.
Paulson had a longstanding history of extensive interaction with Chinese officials. He believed fervently that the US-China relationship would be a, if not the defining force for the 21st century.
He was strongly opposed to confrontation and protectionism. In a press interview in Beijing in September 2006, he emphasised that a key risk facing China was not moving fast enough on reform.
But he was quick to add that Senators Chuck Schumer and Lindsay Graham’s approach to China’s currency (a 27.5% import duty) was incorrect. Paulson said he shared many of their objectives, but added, ‘I don’t agree with their tactics. You’ll never have me favouring protectionist legislation and I will try to talk them out of it.’
He also felt that the renminbi had unfairly taken on a totemic status. In a December 2007 speech to the Asia Society, he said, ‘The renminbi exchange rate has become more than an economic parameter; it has become a touchstone for broader anxieties about competition from China…worries about the effects of foreign competition…have led to a rise in economic nationalism and protectionist sentiments.’
He believed that the US, and Treasury in particular, needed to work closely with China. For him, diplomatic engagement was paramount.
His tenure could be broken down into two periods – mid-2006 to mid-2008, and the months leading up to his departure in early 2009.
In the first period, the substantive argumentation put forward by Paulson and Treasury staff was similar to the Snow era. The broad outlines of the three-part strategy remained in place: renminbi flexibility, boosting domestic demand as part of a shift in the growth model, and financial reform and opening up.
But reflecting on the ground changes, the argumentation deepened. By mid-2007, the impact of China’s heavy foreign exchange intervention was being reflected in surging inflation pressures.
Treasury continued to express concerns about the renminbi’s undervaluation and China’s excessive current account surpluses and reserve accumulation. But in much greater detail, it delved into the implications of Chinese external policies for the domestic economy.
Treasury staff especially focused on how the liquidity build-up associated with foreign exchange intervention was no longer being effectively sterilised. Rather, it was generating higher consumer and asset prices, contributing to low interest rates, spawning high credit growth and excess investment, and thus increasing the prospects for a Chinese boom-bust cycle. Chinese inflation accelerated to 8% in the first half of 2008.
In short, rigid exchange rate management was rendering monetary policy ineffective, while the currency’s undervaluation was perpetuating an economic orientation toward production of exports at the expense of domestic rebalancing toward consumption and services. To drive these points home, the December 2007 foreign exchange report included a box entitled, ‘Challenges to domestic monetary policy from foreign exchange inflows’.
Paulson and team were forceful in repeating and making the connection between the renminbi’s undervaluation and China’s economic distortions. ‘Currency movement alone will not eliminate the distortions in the Chinese economy nor significantly reduce China’s trade surplus. China needs to restructure its economy so that household consumption – rather than exports and excess investment – powers growth. This is the only way China can grow without generating huge trade surpluses.’
Another hallmark of the era’s foreign exchange reports was to quote Chinese official statements about the need for rebalancing and currency appreciation. Treasury chose those quotes carefully amid fierce debate in China. The central bank sought to better control inflation and saw currency flexibility as one key. Others, such as the Commerce Ministry and the National Development and Reform Commission, were concerned about hurting exporters and growth. The US continuously raised concerns. China’s leadership faced the challenge of balancing competing interests.
Given domestic stability in China and on the back of surging Chinese inflation and rising global protectionist sentiment, Chinese officials picked up the pace of renminbi appreciation. During the second half of 2006, the currency rose just over 2% against the dollar. But between end-2006 and end-2007, the renminbi rose a further 6%, and then through mid-2008 another 7.75%.
China then re-pegged the renminbi as the financial crisis took root.
In the period between mid-2008 and early 2009 when Paulson departed Treasury, and as the financial crisis deepened, policy-makers’ attention focused on averting a collapse in the US financial system and staving off economic depression. The tone of US-China currency diplomacy quieted down, especially as both sides worked together to promote global financial stability.
Strategic Economic Dialogue launches
Engagement was the hallmark of the Paulson era. As Paulson stated in remarks on US-China relations December 2008, prior to stepping down, ‘We have learned that engagement works, [it] can help achieve meaningful, tangible results that would not have been possible otherwise.’
Reflecting his strongly held view about the need to work closely with China, immediately after being sworn in Paulson launched the Strategic Economic Dialogue, which Presidents Bush and Hu Jintao announced in September 2006. The SED covered the entire gamut of economic and financial issues between China and the US, bringing together a ‘whole of government’ approach on both sides to bilateral relations. It met first in Beijing in December 2006, and then twice a year throughout the Bush presidency, alternating between China and the US.
The SED brought together all of the key ministries and players from both sides. It helped establish close contacts between the parties, along with comprehensive discussions. They understood each other well. Whether there was agreement or not, no issue was left unturned.
In addition to the normal gamut of economic and financial issues, Paulson emphasised opening up Chinese financial markets to foreign participation. In Paulson’s view, foreign entrants could bring in capital, improved management skills and technology, all of which would strengthen the Chinese financial system and the allocation of capital. This emphasis was not without its critics, who argued that opening up the Chinese financial system to foreign participation distracted from other priorities, including focusing on the renminbi.
Multilateral engagement was also intensified as part of the Paulson era’s focus on the renminbi.
In September 2005, in a speech at the Peterson Institute, Treasury Under Secretary Timothy Adams – obviously referring to the renminbi – stated that when it came to exchange rate surveillance, the IMF appeared to be ‘asleep at the wheel’. In Treasury’s view, the Fund was created to avoid the bilateralisation of exchange rate disputes and beggar-thy-neighbour currency policies. Exchange rate surveillance was at the core of its raison d’être.
US falls foul of IMF
In mid-2006, the IMF launched multilateral consultations with the US, China, euro area, UK and Saudi Arabia. The Fund observed reasonably that tackling global imbalances required addressing key saving and investment policies in the major areas, and that imbalances were impacted by spillovers amongst them. However, participants did not see this format as conducive to implementing major national policy adjustments. US participants disagreed with the implicit equivalence between harmful and distortive Chinese currency practices and admittedly less than desirable US fiscal policy.
The Fund also pursued a revamping of its 1977 decision on exchange rate surveillance. It sought to promulgate a new surveillance decision, enshrining the concept of ‘fundamental (exchange rate) misalignment’ as a lesser hurdle to ‘manipulation’, which involved findings on intent and was highly stigmatised.
Washington felt that the 1977 decision and IMF precedent already gave the Fund sufficient scope to take strong action with China, such as ad hoc or special consultations. The US was unconvinced that countries would be any more accepting – in the words of Treasury staff – of the ‘Purple M’ (fundamental misalignment) than a ‘Scarlet M’ (manipulation).
The Fund insisted that it would take full responsibility for pushing forward the revamping of the surveillance decision and urged Treasury to support its endeavour. The latter finally assented, only then for other IMF members to accuse the US of having forced the revamp. In the end, the decision was adopted with significant Board support, but the process was clearly perceived as entailing brute US force.
Washington’s G7 partners were lukewarm in their backing of US efforts, particularly the UK. While many had reservations about Chinese exchange rate policies, they were wary of getting between the US and China. Some were appreciative of Chinese FDI in their countries. With respect to the IMF’s new surveillance decision, the European Central Bank in particular was unsupportive, concerned that accepting ‘fundamental misalignment’ could raise questions about countries in the European Exchange Rate Mechanism, seeking to eventually join the euro.
Treasury was justified in pursuing a multilateral plank, centred on the IMF. For all of the faults that arose with this strategy, especially the efforts inside the IMF, the vigour and tenacity with which Treasury put the matter on the global stage significantly raised the issue’s profile in China and globally. That was helpful in and of itself.
Extensive engagement was also required at home. Secretary Paulson, Under Secretary Timothy Adams and his successor David McCormick, and Treasury teams engaged in extensive conversations with Congress and committee staff. Testimony was repeatedly offered and rancorous. While aggressive in public, behind the scenes, many prominent Congressmen, including Sander Levin, chair of the ways and means subcommittee on international trade, raised thoughtful questions about whether the multilateral institutions the US helped create after world war two were falling down on their jobs.
Protectionist legislation abounded, be it in the form of import duties put forward by Senators Schumer and Graham, or proposals to make currency undervaluation – calculated by the Commerce Department – a countervailable subsidy. Led by Paulson, the administration pushed back against such proposals, questioning their economic underpinnings, feasibility and WTO consistency.
Throughout the period, Paulson refused steadfastly to designate China for currency manipulation. There was admittedly a case to do so, especially between 2006 and mid-2008. The 1988 legislation governing the foreign exchange report only provided that if ‘manipulation’ were found, Treasury would need to undertake expedited negotiations to remedy the situation. Paulson felt he was on the phone every day with Chinese officials and the SED constituted a de facto negotiation. The renminbi was appreciating, which would have been the desired outcome of discussions in any case. There was concern that an overt naming and shaming of China would cause Beijing to pull away from discussions with Treasury, setting back progress. Finally, Paulson was concerned that a ‘manipulation’ finding might galvanise further congressional legislation.
The renminbi’s appreciation ahead of the onset of the crisis reflected a period of domestic stability in China, and growing awareness among Chinese economic officials that it was in the country’s self-interest to move toward greater flexibility, contain inflationary pressures and improve and modernise monetary management. It was also a period of intense controversy in the US, in which vigorous efforts were made to fend off protectionist pressures. With the onset of the 2008 financial crisis, the intensity and focus on the renminbi ebbed for the time being.
2009-10: Overcoming the crisis, pushing renminbi appreciation
During President Barack Obama’s administration, the Treasury was headed by two secretaries, Tim Geithner and Jack Lew. Its currency policy by two under-secretaries, Lael Brainard and Nathan Sheets.
Renminbi diplomacy could be broadly broken down into three periods. First, between early 2009 and mid-2010; second, between mid-2010 and early 2014; and third, early 2014 through 2016 and the end of the Obama administration.
Between early 2009 and mid-2010, overcoming the financial crisis overrode concerns about renminbi diplomacy. That does not mean, however, that these went ignored completely.
In hurriedly preparing written answers overnight in response to scores of Congressional questions, needed to secure Geithner’s confirmation, a campaign official stuck in that President Obama, backed by many economists, believed that China was manipulating its currency.
Geithner was known to oppose any manipulation finding. Such an act would have been out of step with then ongoing work with China to overcome the crisis. Still, this development created widespread expectation Treasury would label China in the April 2009 report.
Much to public furore, no such thing happened. Instead, the report outlined why China should not be labelled. It pointed to the real appreciation of the renminbi over the preceding year, China’s move to greater flexibility, and the large stimulus package that China implemented to support Chinese domestic demand and prevent a far deeper global crisis. Treasury continued to see the renminbi as undervalued.
Geithner visited China in June 2009 and continued to make the case for reform. While many of the broad substantive arguments echoed those of the Snow and Paulson periods, the articulation evolved and deepened.
Coming on the heels of the financial crisis, for which the US bore much responsibility, Geithner recognised that the US and China, as two leading global powers, needed to co-operate and engage more extensively to address world economic problems. He struck a tone much more of equals. The two countries were partners having special responsibilities for global economic management.
The US should increase its national saving and could no longer be seen as a sole engine for global growth. China needed to shift from reliance on exports to domestic demand, led by consumption. To achieve this, market signals should play a much greater role in Chinese resource allocation. ‘Greater exchange rate flexibility will help reinforce the shift in the composition of growth, encourage resource shifts to support domestic demand, and provide greater ability for monetary policy to achieve sustained growth with low inflation in the future,’ said Geithner.
He emphasised the importance of China and the US working together to tackle global challenges. They should strengthen their financial systems and collaborate in the Financial Stability Board. Geithner added that Washington and Beijing should work together to make the IMF more reflective of the shifting balance of global economic and financial power, and ensure the Fund was adequately resourced. They should also co-operate to keep markets open to trade and investment.
In July 2009 as the financial crisis unfolded, China’s leaders re-pegged the renminbi against the dollar. They mimicked the strategy China used during the Asian financial crisis, believing a peg would contribute to global financial stability. With the recovery from the crisis gaining footing later in 2009 and early 2010, US domestic pressures on currency policy heated up anew.
The October 2009 foreign exchange report concluded that, ‘Although China’s overall policies played an important role in anchoring the global economy in 2009 and promoting a reduction in its current account surplus, the recent lack of flexibility of the renminbi exchange rate and China’s renewed accumulation of foreign exchange reserves risk unwinding some of the progress made in reducing imbalances as stimulus policies are eventually withdrawn and demand by China’s trading partners recovers.’
The Obama administration continued Paulson’s dialogue with China, under the moniker, ‘Strategic and Economic Dialogue’. Reflecting the ampersand, Secretary of State Hillary Clinton led the ‘strategic’ dialogue and Geithner the ‘economic’ dialogue. Exchange rate issues featured prominently in the May 2010 S&ED discussions and Geithner’s subsequent congressional testimony.
In June 2010, with global pressures mounting and ahead of the G20 Leaders Toronto summit, China resumed renminbi appreciation. In a delayed foreign exchange report the following month, Treasury welcomed China’s action, but noted that the key was how fast its currency appreciated. The report underscored that progress had already been achieved; the resumption was significant in and of itself and the renminbi had risen more than 21% against the dollar since July 2005. Still, more work was needed to address the undervaluation of China’s currency, especially in the light of continued current account surpluses and reserve increases.
2010-14: Heightened acrimony
The period from mid-2010 through early 2014 was far more quarrelsome.
Chinese reserves soared between end-2008 and end-2013 to $4tn from around $2tn. The US bilateral trade deficit with China climbed anew, exceeding $300bn.
On the plus side, China’s current account surplus, which had peaked around 10% of GDP in 2007, fell to roughly 5% in 2009 and 2% in 2013. The renminbi rose 12% versus the dollar between June 2010 and end-2013, to Rmb6.05 per dollar from Rmb6.83.
Treasury used the foreign exchange report, S&ED and other bilateral engagements to continue making the case for greater flexibility. The substantive argumentation remained broadly similar as before, focusing on intensified macroeconomic co-operation, developing a more balanced trading relationship, deepening financial sector co-operation and strengthening regional and multilateral co-operation. The aim of macroeconomic co-operation was to help achieve the G20 goals of ‘strong, sustainable and balanced’ growth, including US work to boost national saving and Chinese efforts to strengthen domestic demand and enhance renminbi flexibility.
Washington continued to focus on rebalancing the Chinese economy toward consumption and domestic demand, and spoke often about such Chinese reforms as increasing public spending on health and education, strengthening the social safety net, boosting wages and incomes for ordinary citizens, increasing transfers of corporate profits to households, liberalising interest rates and the services sector, and implementing financial sector reforms to offer greater opportunities to citizens.
But several factors complicated Treasury’s ability to explain Chinese economic and currency developments to Congress and the public.
Though China’s current account surplus fell as a share of GDP, given the strong gains in GDP, the nominal current account surplus remained large. The current account reflected a sharp dichotomy. China’s overall trade surplus remained large, but services swung to a sizeable deficit on the back of rising overseas Chinese tourist payments. For example, in 2013 when China’s overall current account surplus was 1.5% of GDP, the trade surplus was still 3.7% of GDP. Industries focused on the trade surplus, but economists generally look at current account balances.
The shift in China’s services position was unexpected, and most analysts anticipated the country’s current account would swing back to considerable surpluses (as a share of GDP). That did not happen.
The massive reserve build-up appropriately garnered much attention. It was bolstered not only by intervention in the face of the large nominal current account surplus, but also significant foreign direct investment inflows.
Treasury argued that the renminbi throughout was ‘significantly undervalued’. The IMF, however, in its 2012 China Article IV report termed the currency ‘moderately undervalued’.
Chinese authorities in speeches, the S&ED and in the G20 reaffirmed throughout their support for greater flexibility.
The November 2011 Cannes G20 leaders’ statement noted, ‘Countries with large current account surpluses commit to reforms to increase domestic demand, coupled with greater exchange rate flexibility…We affirm our commitment to move more rapidly toward more market-determined exchange rate systems and enhance exchange rate flexibility to reflect underlying economic fundamentals, avoid persistent exchange rate misalignments and refrain from competitive devaluation of currencies.’
There was little let up in proposed congressional legislation during the period, nor much slackening of criticisms of Treasury’s currency policies toward China.
2014-16: Renminbi plummets, rancour continues
In early 2014, China altered its currency policy amid expectations of Fed tightening, a slowing in the Chinese economy, and authorities’ concern that renminbi appreciation was increasingly seen as a one-way bet. Through jawboning and intervention in March, it sent the message that the renminbi should weaken, including against the dollar.
This action triggered large hedging demand for renminbi and capital outflow that persisted through 2016. The March 2014 action pushed the renminbi down against the dollar by 2.5% through August 2015.
That month, China changed how it set its currency reference rate, a move that surprised markets, and sent the renminbi down against the dollar roughly 2.75% within a week. The renminbi fell further against the dollar throughout 2016. Between early 2014 and end-2016, the it dropped roughly 13% against the dollar. Because this was a period of dollar strength, the renminbi’s depreciation on a trade-weighted basis was smaller.
During this period, China’s current account surplus bounced around 2% of GDP. To resist renminbi depreciation, the central bank sold around $1tn.
Treasury’s foreign exchange reports in 2014-15 sought to explain these developments, continuing to take the view that the renminbi was ‘significantly undervalued’ on the basis of medium-term economic fundamentals, which it noted could deviate from short-term developments. Treasury emphasised the need for much greater transparency in China’s foreign exchange management.
In 2016, Treasury overhauled the manner in which it wrote the foreign exchange report, responding to the ‘enhanced criteria’ included in the so-called Bennett Amendment to the Trade Facilitation and Trade Enforcement Act of 2015. The report focused more mechanistically on the scale of bilateral balances with major trading partners, material current account surpluses, and reserve build-ups. The October 2016 report found that China fell afoul of the bilateral balance criteria, and included China on a ‘monitoring list’, even though being placed on this list ostensibly required tripping two criteria.
The S&ED continued. Amid its wide-ranging discussions, the forum emphasised further the need for the renminbi to move to increased flexibility and greater market-orientation. The US welcomed that China was no longer building up reserves and Beijing committed to intervene only when necessary due to disorderly market conditions.
2017-Present: Bad economics, engagement set back, whiplash
When the Trump administration assumed power, the tone and underlying premises of the 2003-16 currency diplomacy toward China initially came under attack.
Candidate Trump promised to declare China a ‘currency manipulator’ on his first day in office. In February 2017, President Trump called China the ‘grand champion’ of currency manipulation.
But by April, the President judged that China was not manipulating its currency and the administration backed off designating China in the foreign exchange report. Treasury Secretary Steven Mnuchin stated that looking at the facts, Trump’s comments reflected a previous period of time.
The administration also decided to continue engagement with China, with the S&ED rebranded the Comprehensive Economic Dialogue.
It appeared that Washington might in some ways follow in the footsteps of continuity of 2003-16.
To balance the hawkish rhetoric of candidate and President Trump with the non-designation, the April 2017 foreign exchange report adopted a far harsher tone than previous reports. It lambasted China for its track record of persistent, large-scale and one-way foreign exchange intervention, which had contributed to massive surpluses and America job losses. Only later, it acknowledged that China had spent nearly $1tn in reserves to limit the fall in the renminbi in the prior years.
It focused heavily on China’s bilateral surplus with the US, which had not been mirrored in the decline in China’s overall surpluses. US legislation on the foreign exchange report requires a focus on bilateral balances. But the Trump administration’s concentration on bilateral balances was much stronger than that of its predecessors, given that economists generally disregard bilateral balances and look instead at overall positions. As with past administrations, the report lamented that China was not making faster progress in reorienting its economy toward domestic demand and consumerism, and also urged China to open up faster.
The process of engagement was dealt a serious blow in July 2017. After the first CED was found disappointing by the administration, the CED was discontinued.
The October 2017 foreign exchange report adopted a more muted tone, though, as did the April 2018 iteration. With capital outflow having abated toward the end of 2016, the renminbi rose against the dollar through Spring 2018.
The April 2018 report began making the argument – and fairly so – that the increasingly non-market direction of China’s economic development posed risks to the longer-term global and Chinese outlook. This argument comported with the longstanding Treasury view that macroeconomic reforms should better support consumption and rebalance the economy away from investment.
Treasury reiterated its oft-made point that China should adhere to its G20 commitments to refrain from engaging in competitive devaluation and not target China’s exchange rate for competitive purposes. It fairly argued that greater transparency on intervention would further this aim.
By the fall of 2018, US-China trade tensions had picked up. The dollar was rising across the board, largely on the back of Fed hikes, and more so against many emerging market currencies than the renminbi. The administration argued for new tariffs, and trade tensions depressed the renminbi against the dollar.
Markets judged that China would be hurt more by a trade war with the US than vice versa. A loss in Chinese exports and competitiveness meant the renminbi should depreciate. The Trump administration was displeased by a weakening renminbi.
The October 2018 and May 2019 foreign exchange reports reflected this change, with the language swinging toward a far tougher posture. The October report went through a lengthy history of Chinese currency management of past decades, and denounced recent renminbi depreciation. It complained, ‘China is not resisting depreciation through intervention as it had in the recent past”.’ Both reports expressed deep concern about possible deterioration in the US bilateral deficit.
In August 2019, with trade tensions mounting, the renminbi fell below 7.0 per dollar, a level Trump saw as a redline. Treasury immediately put out a one-page statement designating China for currency manipulation, despite the reality that China’s current account surplus was well below Treasury’s threshold and China had not been intervening in foreign exchange markets for years.
In a delayed January 2020 foreign exchange report, Treasury reversed its designation, pointing to the phase one US-China trade deal and enforceable commitments by China to refrain from competitive devaluation, not target its exchange rate for competitive gain, and new transparency commitments. There was nothing new in these commitments, and Treasury and the PBoC had in reality signed off on them in Spring 2019 in preparing the phase one agreement.
The Trump administration’s approach to China’s currency has in many fundamental respects reversed the premises of the renminbi diplomacy of the Bush and Obama administrations.
Renminbi diplomacy from 2003-16 emphasised engagement with China on currency reform. While Treasury and the PBoC communicate frequently behind the scenes at international gatherings or by phone, the Trump Administration’s quick abandonment of the CED was a setback for dialogue and engagement.
A key pillar of the Bush and Obama era currency diplomacy was to resist protectionism at home. They sought to secure results from China, while engaging Congress, to keep such legislation at bay. The Trump administration has unilaterally pursued protectionist policies.
It correctly avoided designating China for currency manipulation until August 2019. But it then wrongly did so in response to presidential pique when the renminbi fell below Rmb7 per dollar, though renminbi weakness in large measure was responding to market pressure over Trump’s ratcheting up of trade tariffs.
The administration’s focus on bilateral balances, at the expense of global current account positions, is inconsistent with standard economic analysis. Instead, the administration in designating China overlooked the small current account surplus as a share of GDP and that China had ceased intervention for several years. It is to be welcomed that the administration reversed its errant designation. But the designation, in the face of the Treasury’s own criteria for analysis, has further undermined Treasury’s credibility.
A fundamental argument of this paper is that Treasury’s renminbi diplomacy between 2003-16 can be broadly viewed in hindsight as a success story.
It would be naïve not to recognise that many Americans would find this argument risible.
The best argument for success lies in the data. The current account surplus has largely gone away. In 2007, China’s was 10% of GDP, it is now closer to 1%. The renminbi was significantly undervalued, but it is now, according to the IMF, fairly valued. China has stopped intervening in foreign exchange markets and ostensibly hasn’t been acquiring reserves since early 2014.
But to suggest that the story is an outright or unmitigated success, let alone on the basis of the data above, would be simplistic. Treasury officials undoubtedly made mistakes along the way, and the US was loath to show much humility, despite its own policy errors and contributions to global imbalances.
From a US perspective, the process can be seen as having been too slow to unfold. Further, even if it can be seen as a success today with hindsight, that is scant comfort to American workers who may have lost their jobs in the meantime.
It is a success, though, in the sense that Treasury officials in the Bush and Obama administrations were central actors in fostering change in Chinese currency policy. They worked hard throughout, marshalling the tools at their disposal to affect fundamental change in the policies of not only another sovereign country, but the world’s second largest economy undergoing a massive transformation. These enormous efforts were essential in influencing the changes in currency policy undertaken by Chinese authorities.
Direct engagement with Chinese officials was unprecedented, be it bilaterally, through the SED, S&ED and numerous other meetings, or multilaterally through the IMF, G7 and G20. Over the years, Washington developed close contacts with Chinese financial authorities at all levels. Whether seeing eye-to-eye or not, officials on both sides of the Pacific knew whom to call, spoke frankly and increasingly developed a solid understanding of the other’s positions and constraints. As Paulson argued, engagement in and of itself yielded fruit.
Treasury sharpened its analytic argumentation throughout, recognising that China would change policies only if it were in its own self-interest. It understood China would not change its exchange rate policies just because of US pressure.
Treasury officials in this era put forward credible and robust arguments about how exchange rate reforms, in conjunction with other macroeconomic and financial sector policy changes, would strengthen China’s own economic future. Treasury reached out as well, along with the White House, to the Chinese President and Premier to go over and above bureaucratic infighting in Beijing.
These arguments reinforced the central bank’s work and modernisation agenda, and countered the interests of opponents of exchange rate reforms. They may have also supported the leadership’s wishes to gradually pursue greater market orientation.
Congress in many ways helped Treasury’s efforts. The strength of congressional rhetoric and protectionist threats at times helped reinforce the weight of Washington’s voice in Beijing amid competing Chinese voices.
But harsh congressional rhetoric also had drawbacks. China’s leaders at times felt the US was blaming China for many of its own inadequacies, including public anxiety about technological change and globalisation. In addition, China felt American policies were hardly ideal, especially after the crisis, and that the US needed to get its own house in order. Following the 2008 financial crisis, Chinese officials often told US authorities that America used to be seen as the teacher, but the pupil now questioned the teacher’s teachings.
Working with the administration and Congress, while pressuring and engaging China, Treasury from 2003-16 was largely able to keep US protectionist legislation on exchange rates at bay. Proposals were often tabled, but didn’t make it through Congress.
President Trump, as his predecessors, has complained vigorously and with legitimacy about China’s state-directed economic policies, including industrial policies, large subsidisation, and forced technology transfers. President Xi Jinping’s growing authoritarianism will only exacerbate these problems.
But the retreat from engagement, the invocation of protectionism and the errant designation of the renminbi in August, 2019, along with the rhetoric surrounding China’s currency more generally, represent a fundamental departure from the 2003-16 diplomacy.
Given the role of the state and the history of China’s central planning, saving and investment decisions are still quite distorted, with implications for China’s external position. The distortions, though, largely reflect domestic policies, and no longer the renminbi’s exchange rate. Hence, while external imbalances have dissipated, massive underlying domestic distortions remain.
 While many industries vociferously complained, others did not. For example, US automakers, while frequently visiting Treasury to raise concerns about the value of the Japanese yen, rarely expressed a view on the renminbi given joint venture operations in China.
 The paper throughout will emphasise the renminbi’s value versus the dollar. If the renminbi follows the dollar up (down), then it is rising (falling) in nominal terms on a trade-weighted basis. Further adjustments are needed for inflation differentials to measure real currency movements. Trade weighted and real movements, far more important than Rmb/dollar movements for surpluses, will also be noted at times in the paper.
 See Under Secretary for International Affairs, Timothy Adams, testimony before the Senate finance committee – ‘US-China Economic Relationship Revisited’; 3/29/2006.
 It is important to recognise that the standard for so-called currency manipulation, consistent with IMF guidelines, entails manipulation ‘for purposes of preventing effective balance of payments adjustments or gaining unfair competitive advantage in international trade’. See March 2005, Treasury report to Congress assessing currency manipulation. https://www.treasury.gov/press-center/press-releases/Documents/js2308.pdf
 For a good summary of the period and US legislative efforts, see https://www.everycrsreport.com/reports/RS21625.html#_Toc362345930. Congressional Research Service, ‘China’s Currency Policy: An Analysis of the Economic Issues’; July 2013.
 These developments are discussed in great detail in Paul Blustein, ‘A Flop and a Debacle: Inside the IMF’s Global Rebalancing Act’, CIGI papers #4, June 2012. Chapter 5 of Blustein’s latest book, Schism: China, America, and the Fracturing of the Global Trading System, reprises much of this terrain; CIGI, 2019. This paper skips over subsequent developments with respect to IMF surveillance decision, which entailed the IMF jettisoning the 2007 decision in favour of a new 2012 ‘integrated surveillance decision’ which further watered down Fund foreign exchange surveillance. The Fund did, however, in response to US pressures at the time commence publication of the IMF’s ‘External Sector Report’, which represents a considerable beefing up of IMF exchange rate analysis, though the Fund continues to shy away from making hard judgements on exchange rate policies.
 At the time, IMF members, responding to a US proposal, were working to increase IMF resources in the emergency back-up New Arrangements to Borrow; China and the US were important contributors. Washington was signaling that, as under Snow and Paulson, it was prepared to support a higher Chinese capital share in the IMF in reflection of China’s growing global weight.
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