Why the U.S. and China Spar On Currency Manipulation

(Bloomberg) -- It didn’t happen on Day 1 of Donald Trump’s presidency, as he had vowed, but 2 1/2 years later he fulfilled one of his campaign pledges: to have China branded a currency manipulator. Less than six months later, the U.S. Treasury lifted the tag, saying the Chinese government had made “enforceable commitments” not to devalue the yuan. The about face came just days ahead of an expected truce in Trump’s trade war with China. But the battles aren’t necessarily over. While no major U.S. trading partner is listed as a manipulator now, Switzerland was added to a monitoring list, joining China, Japan, Korea, Germany, Italy, Ireland, Singapore, Malaysia and Vietnam.

1. What does the manipulator label mean?

Not much immediately. According to the U.S. law, an offender could be excluded from U.S. government procurement contracts, and the Treasury secretary could be directed to ask the International Monetary Fund for more rigorous monitoring of its monetary policies. But that can only happen if the U.S. found insufficient progress in remedying the situation a year after the designation. In China’s case, the label lasted from August 2019 until January 2020. Another potential sanction -- cutting off new assistance from the Overseas Private Investment Corp., a U.S. government agency that helps fund development projects -- has been in effect for China since 1990 anyway, as part of the U.S. response to the 1989 crackdown on protesters in Tiananmen Square.

2. Why the focus on China?

American politicians have long accused the government in Beijing of depreciating the yuan against the dollar to aid exporters by making their products cheaper overseas. The U.S. first labeled China a currency manipulator, from 1992 through 1994. Yet successive U.S. presidents since then held the line against such a move, worrying about the diplomatic fallout. That approach changed under Trump, who made a hawkish, America-first trade policy a centerpiece of his 2016 campaign.

3. What are the criteria?

There are three, adopted under President Barack Obama and updated under Trump (see chart below), that a country is supposed to meet to be labeled a manipulator. Two out of three gets you on the monitoring list. In China’s case, both the recent naming and un-naming were unusual. China met only one of the conditions in the semiannual currency report in May 2019, but was kept on the monitoring list partly due to its large trade imbalance. The Treasury then went ahead and labeled China a manipulator in August, before the next report was due, just hours after the yuan had weakened to more than 7 per dollar, a line it hadn’t crossed in decades. The Jan. 13 report was also early, landing two days before the U.S. and China were to sign a “phase one” trade deal.

4. So, is China a currency manipulator?

It depends who you ask. The yuan doesn’t float freely but is managed using a fairly opaque system in which the central bank, the People’s Bank of China, fixes daily reference rates. While China’s competitors, including outside the U.S., have long complained that an intentionally undervalued yuan gives Chinese exporters an unfair advantage, the past decade has seen China take steps to let the yuan’s value fluctuate against the U.S. dollar. It became one of the IMF’s five designated reserve currencies in 2016 — a reflection that China was starting to play the “economic game by the rules,” as IMF Managing Director Christine Lagarde put it at the time. The U.S. even stopped calling the currency “significantly undervalued” in 2016. In its latest decision, the Treasury urged China to “increase public understanding” of the relationship between its central bank and the “foreign-exchange activities of the state-owned banks,” including in the market for yuan circulating outside China. The Treasury also said the PBOC “appears to have largely refrained” from intervention in 2019.

5. What’s happened since the trade war began?

A long slide in the yuan ensued. Yet in August 2018, the PBOC made it more expensive for local traders to bet against the yuan -- a surprise move that analysts saiddemonstrated the depreciation had gone far enough for the central bank. A year later, when the PBOC set the daily reference rate at a weaker level than analysts and traders had projected, helping send the yuan past the 7 per dollar level, it was seen as a sign that Beijing was comfortable to allow depreciation again. That was then. The trade agreement includes a promise by China to keep the currency stable and the currency hit a six-month high after the manipulator tag was lifted.

6. Is a weaker yuan all good news for China?

It would make Chinese goods more competitive relative to U.S. products. But that comes at a cost. A weaker yuan can stoke inflation, as imports including oil become more expensive. A weaker currency also creates incentives for households and companies to move their money out of the country and into stronger currencies. That would force the government to draw on its reserves -- the world’s biggest at more than $3 trillion -- to buy yuan to prop up its value. In 2015, an abrupt devaluation spooked global markets and triggered panicky capital outflows. The country burned through about $1 trillion of reserves to stem that exodus.

7. What about the others on the list?

The Treasury had some advice for each. Switzerland, the newcomer to the monitoring list, should “more forcefully support domestic economic activity,” it said. “Despite borrowing costs for the Swiss government being among the lowest in the world, fiscal policy remains underutilized.” Germany, the Netherlands and Korea all have “sufficient fiscal space for substantial pro-growth stimulus,” it said, which could ease pressure for monetary moves. Treasury said it was worried about the high savings rates in Singapore, and urged Japan to enact “critical structural reforms” to spur growth. Vietnam should intervene less “and allow for movements in the exchange rate that reflect economic fundamentals.” Meanwhile, as U.S.-China tensions ease, the European Union’s trade chief is trying to head off a transatlantic war on other fronts.

The Reference Shelf

• The U.S. Treasury’s May report on currency manipulation, and January’s.
• QuickTakes on intellectual property, the trade war, the yuan, currency wars and China’s slowing economy.
• Trump’s “chaotic messaging” on the dollar.

--With assistance from Paul Geitner and Scott Lanman.

To contact the reporter on this story: Enda Curran in Hong Kong at ecurran8@bloomberg.net

To contact the editors responsible for this story: Malcolm Scott at mscott23@bloomberg.net, Paul Geitner

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