The question we ask here is: Who is the currency manipulator, China or Trump? Would it have been Trump if the U.S. had intervened? Or is it China, as Trump and the U.S. Treasury allege?
What Constitutes Currency Manipulation?
The point of departure is the definition of currency manipulation, which apparently is in the eye of the beholder.
But we use the IMF’s language, as we judge it to be the official and objective arbiter in such matters. IMF Article IV requires members to “avoid manipulating exchange rates or the international monetary system to prevent effective balance of payments adjustment or to gain an unfair competitive advantage” (italics our emphasis). In its 1977 Decision on Surveillance over Exchange Rate Policies, the IMF established that one of the developments “which might indicate the need for discussion with a member” about its exchange rate policies is protracted, large-scale, and one-way intervention in the foreign exchange market.
Trump’s definition, on the other hand, appears to be that China is a currency manipulator (concerning the dollar) if there is a large and protracted bilateral deficit in the U.S. current account. Treasury’s definition appears to be flexible and, in this case, aligned with Trump’s.
China’s Managed Float Regime
To understand the issue of currency manipulation by China, it is useful to start by understanding its exchange rate regime. China’s currency is the renminbi (RMB). China officially moved from a fixed exchange rate regime to a managed float in 2005, though in practice it was not a floating regime, with the IMF characterizing it instead as a crawling peg for much of the following decade or so.1 The most recent major reforms began in 2016–preceded by the publication in late 2015 of RMB exchange rate indices to provide information on what basket of currencies was guiding policy. Currently, at the beginning of each day, the RMB/USD exchange rate is targeted using a “central parity rate” (“the fix”) and is allowed to move 2% in either direction during the day in response to market forces. The level of the RMB/USD exchange rate at the end of the previous day is an important factor in the determination of the RMB/USD fix for the next day.2 This allows for gradual movements in the RMB/USD exchange rate in response to market forces.3
1It was actually classified as having remained in a fixed peg arrangement until mid-2006. It was reclassified as a stabilized arrangement from mid-2008 to mid-2010 when the exchange rate was managed during the global financial crisis.
2 There is also an adjustment to the central parity rate to maintain the stability of the RMB against a basket of currencies. 3 The PBOC has also intervened to offset what is deemed to be “irrational” or “procyclical” herding movements in the RMB. When those pressures abated, the managed float kept the exchange rate in line with market fundamentals.
Is China a Currency Manipulator?
No. It was, to be sure, for some time, some time ago. Following the 2005 FX reform, the RMB appreciated gradually but substantially over roughly the next decade even as China continued to intervene and accumulate FX reserves. That changed in mid-2014 when China turned to sell reserves to counteract downward pressure on the RMB. The IMF assessed that the RMB was no longer undervalued in summer 2015. In its 2019 Article IV consultation for China, the IMF assessed that the RMB was broadly in line with fundamentals. Therefore, China is not, under the present regime and today, a currency manipulator.
Why does Trump say he sees China as a currency manipulator? First, it is likely because he infers that classification from the large U.S bilateral current account deficit with China. Second, it is a rationale for imposing tariffs as part of his negotiations with China about a trade agreement aimed at diminishing that bilateral trade imbalance. Third, he observes an ongoing appreciation of the dollar, and calling China a currency manipulator may justify U.S. FX intervention as a way to lean against that.
Is Trump an (Almost) Currency Manipulator?
Yes. In July 2019, Trump said he was considering intervening in the FX market to lower the USD/RMB exchange rate, but then backed off. Soon after that, Trump accused China of currency manipulation, and, subsequently, Treasury officially designated China as such. Note, however, this is the first time the Treasury has done so since 1994, and it happened right after the decline in the RMB that followed the last round of tariffs.
Tariffs and Equilibrium Exchange Rates
That brings us to the effect of tariffs on exchange rates. Tariffs affect equilibrium FX rates. When the U.S. imposed additional tariffs on China, market forces put downward pressure on the RMB to offset, in part or whole, the effect of tariffs on trade between the two countries. Market forces thus moved the RMB to keep it broadly in line with market fundamentals.
Trade Barriers, Competitive Advantage, and Exchange Rates
China is widely seen in the U.S. as a “bad actor” in the global economy, not because of perceived currency manipulation but because of the significant non-tariff barriers to both trade and investment. Understandably, Trump has tried to press China to give up or scale back the non-tariff trade barriers. These include subsidies to state-owned enterprises that compete with U.S. companies and perceived failure to protect intellectual property rights.
But here’s the rub. If a country imposes a quota on imports–or other non-tariff barriers–and that country operates in a flexible (or in this case a managed float) FX regime, in theory, its currency will come under pressure to depreciate and hence offset at least in part the effect of trade barriers on its current account.
Monetary Policy, Exchange Rates, and Currency Manipulation
Another reason that Trump was exasperated is that the dollar has been appreciating on a trade-weighted basis and that has been putting downward pressure on aggregate demand and growth.
This appreciation has largely been driven by a turn in anticipated policy direction–for example, back to more accommodation by the ECB–leading to declines in interest rates in the Eurozone, capital inflows to the U.S., and an appreciation of the dollar. So are those countries guilty of currency manipulation as well?
Now there has been a longstanding controversy about whether an easing of monetary policy by a country that lowers its exchange rate and stimulates its economy at the expense of its trading partners is a form of currency manipulation. That depends on how one sees the responsibility of central banks. Should a central bank’s policy be focused exclusively on its own domestic objectives? Concerning the Fed, those objectives are employment and inflation in the U.S. Or should a central bank be a good global citizen and take into account the effect on other countries? This applies mostly to the U.S. because of its size and far-reaching global influence.
The consensus, at least among major central banks, is that each country, including the U.S., should manage its own monetary policy exclusively concerning domestic objectives, of course taking into account any spillovers back to their economies from the effects of their policies on others. Having said that, as the FOMC conducted QE, many countries and some observers in the U.S. saw it as currency manipulation, as it resulted in lower U.S. interest rates and a depreciation of the dollar. So, that’s just one reason that currency manipulation is in the eye of the beholder. Final comment: So you decide!
The IMF says the RMB is broadly in line with fundamentals and specifically is not undervalued relative to the dollar. China has not for some time been accumulating foreign exchange reserves to hold down the RMB, as it did for so long. Nevertheless, Trump and Treasury allege China is a currency manipulator. Should the U.S. intervene to depreciate the dollar relative to the RMB, it would, in my view, be guilty of currency manipulation.