Trump’s Manipulation of Currency Manipulation
By treating international trade as a zero-sum game in which the US makes its own rules, President Donald Trump's administration has weakened the incentive for countries to engage in policy cooperation. Why should China bow to a US that treats it as an enemy?
LONDON – The weaponization of currency has rarely ended well for the United States. Look no further than the unilateral 1971 decision of President Richard Nixon’s administration to cancel the US dollar’s direct international convertibility to gold – a key element of the “Nixon Shock” that destabilized floating currencies and led to stagflation later in the decade. But that hasn’t stopped President Donald Trump’s administration from (mis)labeling China a currency manipulator.
The US has long accused China of keeping the renminbi artificially low, in order to secure an unfair advantage in international trade. But it has generally refrained from harsh action, and, until this latest decision, had not applied the “currency manipulator” label since 1994. Even during the mid-2000s, when the renminbi was widely considered to be significantly undervalued, US President George W. Bush’s administration chose not to make that designation, and instead pursued the bilateral Strategic Economic Dialogue on currency and other economic issues.
But the renminbi’s recent drop below the psychologically significant threshold of CN¥7 to the dollar for the first time since 2008 was too much for the Trump administration to take. So, in a symbolic move that escalates America’s ongoing trade war with China, the US Treasury made the official designation.
It is not at all clear, however, whether the label applies. A country is considered to be a currency manipulator if its monetary authority intervenes to engineer a devaluation, in order to boost the global competitiveness of its exports. The renminbi’s recent decline, however, was not the result of policy action.
Nowadays, China maintains a managed floating exchange-rate regime: the renminbi’s value can fluctuate freely within a 2% band. But, because the authorities reset the exchange rate daily, a long period of weakness gradually moves the exchange rate downward, even if daily movements are marginal. That is what happened this week.
In fact, far from intervening to devalue the renminbi, the People’s Bank of China (PBOC) has in recent years been deploying its foreign-exchange reserves to prop it up. The difference this time is that it chose not to intervene, thereby allowing the currency to fall.
The decision was probably driven largely by China’s longstanding determination to transform the renminbi into a major international currency that is liquid and widely accepted. The country’s leaders know that frequent market interventions undermine the renminbi’s credibility with non-resident holders of the currency. Moreover, those interventions come at a high cost. In 2015-16, supporting the renminbi depleted the country’s foreign-exchange reserves by some $1 trillion.
This is not to say that China will not intervene further. After all, a weak currency is a major problem for China – a point that seems to elude the Trump administration. For one thing, by raising the cost of imports, a weaker renminbi would hurt the domestic demand that China is so eager to foster, as part of its strategy to shift the country’s growth model away from exports.
Moreover, a weak renminbi may trigger capital outflows, at a time when total debt stands at a whopping 300% of GDP. A stronger and more stable renminbi, by contrast, would mitigate the debt exposure of Chinese companies and provincial governments, without jeopardizing financial stability.
Given this, the PBOC is likely to step in if the renminbi falls much lower. But it will be doing so on its own terms rather than to meet a specified target, let alone to please the US, which would nonetheless benefit. In the throes of Trump’s trade war, and following an interest-rate cut by the Federal Reserve, the US could use any growth boost it can get.
Yet, even if China’s interventions are designed to curb depreciation, the Trump administration may nonetheless use them to justify the currency manipulator designation. This points to the dilemma Trump has created for the rest of the world. By treating international trade as a winner-take-all, zero-sum game in which the US makes its own rules, the Trump administration has weakened the incentive for countries to engage in the kind of policy cooperation that has been a hallmark of the international economic order since World War II. Why should China bow to a US that treats it as an economic enemy?
To be sure, it remains unclear whether the US Treasury has advanced the kind of formal proceedings – which normally involve the International Monetary Fund – against China that would usually follow official accusations of currency manipulation. And the Trump administration has a track record of making big threats and then backing away (while claiming credit for averting disaster).
By escalating tensions and fueling uncertainty, however, Trump’s reckless posturing can have serious consequences, even if he does not follow through. At a time when the global economy is slowing down, this is a risk nobody should be willing to take.
Can America and China Avoid a Currency War?
Although the current poor state of Sino-American relations may make even a very limited currency détente unattainable, such a pact is not outside the realm of possibility. Ultimately, both America and China might see some advantage in taking currency conflict off the table, in the hope of preventing wider damage to themselves and others.
SANTA BARBARA – China’s currency, the renminbi, weakened slightly against the dollar at the start of this week. Around the world, the immediate response was panic. Financial markets tumbled, US President Donald Trump’s administration formally labeled China a currency manipulator, and fears of a new currency war spread like wildfire. To describe all this as an overreaction would be a gross understatement. A currency war has not erupted – at least, not yet.
But the danger is real. Although markets now appear to be recovering somewhat, America and China remain locked in a perilous trade war with no end in sight. The United States is still poised to impose a 10% tariff on some $300 billion worth of Chinese imports. It does not seem unreasonable to suppose that China might then retaliate by engineering a substantial devaluation of its currency. After all, a cheaper renminbi would go a long way toward offsetting the impact of Trump’s tariffs on the prices of Chinese goods in the US.
But, because devaluation would also carry significant risks for China, the country’s leaders will be hesitant to take this step. Many of China’s biggest enterprises have borrowed heavily in dollars, and a weaker renminbi would greatly increase the cost of servicing this external debt. Worse, the prospect of devaluation could spark massive capital flight from China as anxious companies and individuals seek to protect the value of their assets. That is what happened four years ago when the renminbi was allowed to weaken significantly, and the Chinese authorities subsequently had to spend $1 trillion in foreign-exchange reserves to prevent the currency from crashing.
It seems unlikely, therefore, that China is about to declare all-out currency war. What happened earlier this week was much subtler – in effect, a shot across America’s bow. The renminbi was already close to the symbolic level of CN¥7 per US dollar. By setting their daily benchmark rate for the currency at a smidgen below CN¥7, the Chinese authorities created room for currency traders to push the market rate temporarily above CN¥7 – an effective devaluation. Although the actual size of the devaluation was minuscule, the psychological impact was enormous. China was reminding America that it still has many economic arrows in its quiver.
Unfortunately, the Trump administration responded in typical blunderbuss fashion, mistaking the modest Chinese signal for something more sinister. By immediately declaring China a currency manipulator, the US succeeded only in hardening positions on both sides.
To avoid losing face, Chinese leaders may now feel compelled to respond in kind. They could make good on the threat of devaluation, or pull out some of its other arrows. For example, China could embargo exports of the rare earth minerals that are so vital to America’s tech industry, or prolong its boycott of US agricultural products. Or it could go beyond the realm of commerce and stir up trouble in the South China Sea or the Taiwan Strait. In short, relations between the world’s two largest economies could go from bad to much worse.
Can further escalation be avoided? One way to avoid that outcome might be to look to a neutral arbiter to adjudicate the currency issue. The most obvious candidate is the International Monetary Fund, one of whose main functions is to oversee the “rules of the game” in international monetary affairs. All Fund members have pledged to avoid exchange-rate manipulation, and all are formally subject to “firm” Fund surveillance of their currency policies. In principle, if America and China truly want to avoid a monetary conflict, they could ask the IMF to step in to settle matters.
In practice, however, the Fund’s authority is sadly limited. The IMF has no powers to enforce rulings. At best, all it can do is “name and shame” currency manipulators. And in the end, it is hard to imagine either America or China kowtowing to a toothless multilateral organization. Can anyone really picture Trump submitting to the judgment of a bunch of unaccountable international civil servants?
A slightly more realistic option might be a direct bargain between the US and Chinese governments – perhaps also including the European Central Bank and one or two other monetary powers – to achieve some form of currency détente.
There is precedent for such a deal. Back in 1936, following more than a half-decade of uncontrolled competitive devaluations during the Great Depression, the main financial powers of the day – the US, Britain, and France – agreed to an informal arrangement for mutual exchange-rate stabilization. Jokingly called the “twenty-four-hour gold standard,” the Tripartite Agreement committed each country to give 24 hours’ notice of any change in its currency’s price. Though far from perfect, the pact did manage to restore some semblance of order to monetary affairs.
A similar agreement today would be more difficult to negotiate. In the 1930s, America, Britain, and France were on reasonably good terms. Present-day America and China, by contrast, are strategic adversaries engaged in a trade war, and even a very limited exchange-rate initiative might prove unattainable. Yet it is not outside the realm of possibility. Ultimately, both sides might see some advantage in taking currency conflict off the table, in the hope of preventing wider damage to themselves and others.
The Currency Manipulation Game
The United States government's assertion that the recent depreciation of the renminbi amounts to currency manipulation is not true. It would be more correct to say that the Chinese authorities gave in to market pressure – the immediate source of which was US President Donald Trump’s announcement of new tariffs on Chinese goods.
CAMBRIDGE – The trade war between the United States and China is heating up again, with US President Donald Trump abruptly announcing plans to impose a 10% tariff on the $300 billion worth of imports from China that he had so far left untouched. The Chinese authorities then allowed their currency, the renminbi, to fall below the symbolic threshold of CN¥7 per US dollar. The Trump administration promptly responded by naming China a “currency manipulator” – the first time the US had done that to any country in 25 years. Pundits declared a currency war, and investors immediately sent global stock markets lower.
The US assertion that the recent depreciation of the renminbi amounts to currency manipulation is not true. It would be more correct to say that the Chinese authorities gave in to market pressure – the immediate source of which was none other than Trump’s announcement of the new tariffs.
Economic theory says that tariffs do not improve a country’s trade balance in the way their proponents think they do. When an exchange rate is market-determined, it automatically moves to offset the tariff. Intuitively, if tariffs discourage American consumers from buying imported Chinese goods, then demand for renminbi weakens, and the currency’s price falls.
The task of evaluating whether America’s trading partners manipulate their currencies lies with the US Treasury Department, which uses three criteria. Two of the three coincide with internationally agreed yardsticks for manipulation under the Articles of Agreement of the International Monetary Fund: persistent one-sided intervention by the country to push down the value of its currency, and a large current-account surplus. Neither of these apply to China today.
Since the US Congress assigned this task to the Treasury in 1988, the Department has fulfilled its mandate professionally, regardless of who was in the White House. The sudden decision to label China a currency manipulator, despite it not meeting the criteria, is yet another case of Trump heedlessly running roughshod over established norms, professional expertise, the long-term credibility of US institutions, and even the plain meaning of the law.
To be sure, there was a time when China did act to keep the renminbi substantially undervalued. From 2004 to mid-2014, and particularly in 2004-08, the Chinese authorities intervened heavily to slow down the currency’s market-driven appreciation. Over this ten-year period, however, the renminbi still appreciated by 30% against the dollar, peaking in 2014.
Then the wind changed, and market sentiment turned against the renminbi. For the past five years, contrary to what Trump and some other US politicians often claim, the Chinese authorities have intervened to slow downthe depreciation of the currency. In 2015 and 2016, the People’s Bank of China spent $1 trillion in foreign-exchange reserves (out of a total of $4 trillion) in an effort to prop up the exchange rate – by far the largest intervention in history to support the value of a currency.
The Chinese authorities’ recent decision to let the renminbi break the CN¥7 barrier may well have been a deliberate response to Trump’s latest tariff offensive. At the same time, however, China remains concerned that its currency might slide too far too fast and destabilize financial markets.
Trump, meanwhile, is a master at accusing others of transgressions that he himself has committed or is considering. While accusing China of currency manipulation, he wants to do the same with the dollar. Not content with publicly pressuring the US Federal Reserve to cut interest rates, Trump has explicitly attempted to talk down the currency. Clearly, he sees the world as a game of competitive depreciation.
The Trump administration has even considered the possibility of intervening directly in the foreign-exchange market to weaken the dollar. (“I could do that in two seconds if I wanted,” Trump said on July 26.)
Yet such a move seems unlikely. The last US effort to depreciate the dollar against other currencies, the 1985 Plaza Accord, worked only because it was part of a coordinated G7 initiative to correct an acknowledged exchange-rate misalignment.
If America were now to engage in a pure currency war against China, it would find itself outmatched, because the US Treasury has only a fraction of the firepower available to the Chinese authorities for foreign-exchange intervention. Furthermore, no matter how crazy US policy gets, investors continue to respond to any uptick in global uncertainty by piling into dollars, the world’s number-one safe-haven currency. Paradoxically, therefore, Trumpian volatility can send the dollar up rather than down.
More generally, major governments have so far abided by a 2013 agreement to refrain from competitive depreciation, in the core sense of explicitly talking down currencies or intervening in foreign-exchange markets. But if currency wars are defined much more broadly to include central banks’ decisions to ease monetary policy with the side effect of depreciating their currencies, then the windmills at which Trump is quixotically tilting may not be wholly imaginary. For example, the Bank of England responded to the Brexit referendum with monetary stimulus that depreciated the pound. More recently, the European Central Bank signaled a further easing of monetary policy in response to slower eurozone growth.
Fears of currency wars (or competitive depreciation) have always gone hand in hand with the desire to avoid trade wars. Both concerns are rooted in the “beggar-thy-neighbor” policies of the Great Depression, when countries tried to gain a competitive advantage vis-à-vis their trading partners in a collectively futile exercise.
In truth, however, currency wars are less damaging than trade wars. Whereas a currency war is likely to result in looser global monetary policy, an all-out trade war could derail the global economy and financial markets.
The real significance of the US decision to label China a currency manipulator, therefore, is that it represents a further escalation of the two countries’ avoidable trade war. And, sadly, Fed interest-rate cuts may give US politicians the impression that monetary policy can repair the damage caused by their own trade-policy mistakes.
Trade Disruption Is a Symptom of a Deeper Malaise
Trade tensions are a symptom rather than a cause of the world’s underlying economic and financial malaise. Moreover, an excessive focus on trade could deflect policymakers’ attention from other measures needed to ensure faster and more inclusive growth in a genuinely stable financial environment.
NEW YORK – It’s only a matter of time until the escalating tensions between China and the United States prompt many more economists to warn of an impending global economic recession coupled with financial instability. On August 5, Bloomberg News said that the yield curve, a closely watched market metric, “Blares Loudest US Recession Warning Since 2007.” And Larry Summers, a former US Treasury Secretary who was also closely involved in crisis-management efforts in 2008-09, recently tweeted that “we may well be at the most dangerous financial moment … since 2009.”
Many economists argue that resolving US-China trade tensions is the best way to avoid significant global economic and financial disruption. Yet, while necessary, this would be far from sufficient.
Don’t get me wrong: the focus on the deteriorating relations between China and America is entirely understandable. After all, their worsening dispute increases the risk of a trade war which, coupled with a currency war, would lead to “beggar-thy-neighbor” (that is, lose-lose) outcomes cascading throughout the global economy. As growth prospects deteriorated, debt and leverage issues would come to the fore in certain countries, adding financial instability to an already damaging economic cocktail. And with the US-China row now extending beyond economics to include national-security and domestic political issues, the best-case scenario on trade is a series of ceasefires; the more likely outcome is escalating tensions.
Yet, when viewed in the broader context of the past decade, trade tensions turn out to be a symptom rather than a cause of the world’s underlying economic and financial malaise. In fact, an excessive focus on trade risks is deflecting policymakers’ attention from other measures needed to ensure faster and more inclusive growth in a genuinely stable financial environment.
Policymakers must also contend with growing political pressure on central banks, the backlash against the inequality trifecta (of income, wealth, and opportunity), the politics of anger, the growth of anti-establishment movements, the loss of trust in governments and expert opinion, regional economic and geopolitical tensions, the growing risk of financial instability, threats to long-term financial-protection products, and a general sense of economic insecurity.
As I argued in The Only Game in Town, all of these recent developments – and also, of course, the growing US-China tensions – are related in a meaningful way to two basic and persistent features of the global economy since the 2008 financial crisis.
The first is the prolonged period in which economic growth has been not only too low but also insufficiently inclusive. As a result, growing segments of the population have felt marginalized, alienated, and angry – leading to unexpected election outcomes, the rise of populist and nationalist movements, and, in a few cases, social unrest.
The second post-crisis feature is the persistent over-reliance on the pain-numbing but distortionary medicine of central-bank liquidity, rather than a more balanced policy mix that seeks to ease the (mainly structural, but also cyclical) impediments to faster, more inclusive growth. Monetary policy has not been very effective in boosting sustainable growth, but it has lifted asset prices significantly. This has further fueled complaints that the system favors the already-rich and privileged rather than serving the broader population – let alone helping more disadvantaged groups.
If both these features persist, the global economy will soon enough come to an uncomfortable binary prospect on the road ahead. At this “T-junction,” the current, increasingly unsustainable path will give way either to a much worse outcome involving recessions, financial instability, and rising political and social tensions, or, more optimistically, to a pick-up in inclusive growth and genuine financial stability as the governance system finally responds to popular pressure.
Moreover, the journey to the neck of this T-junction is itself increasingly uncertain. In particular, the protracted use of unconventional monetary policies has entailed costs and risks that have intensified over time. These include attacks on the operational autonomy of central banks, the excessive decoupling of asset prices from their underlying economic and corporate fundamentals, and systemic overpromising of liquidity to end users (particularly in the non-bank sector). Today, a policy mistake or a market accident could make the journey much faster and a lot bumpier.
To avoid a nasty outcome for the global economy and financial system, China and America need to resolve their differences in the context of a more comprehensive policy compact that also involves other leading economies (especially Europe).
Efforts to revitalize free but fairer trade should start by addressing genuine US and European grievances vis-à-vis China regarding intellectual-property theft, forced transfer of technology, excessive subsidization, and other unfair trade and investment practices. And this in turn should serve as the foundation for a comprehensive multilateral effort to remove constraints on actual and potential growth.
Such an initiative would include infrastructure rehabilitation and modernization in Europe and the US, more balanced fiscal policies in Europe and a stronger regional economic architecture, stronger social safety nets around the world, and targeted liberalization and deregulation in China and Europe.
With concerted global action of this type, the world economy could navigate the upcoming T-junction favorably. Without it, current complaints about economic and financial instability and insecurity could pale in comparison to what comes next.