Currency manipulation? The US may have more to answer for than China

Two weeks ago, the US Treasury Department designated China a âcurrency manipulatorâ. Given the ongoing China-US trade war and negotiations, the real implications of such a designation are relatively insignificant. But has China really been a currency manipulator? The US uses three criteria to determine if a country is a currency manipulator: it must have a large trade surplus with the US; a large overall current account surplus, and; has intervened actively in the currency market. However, only one applies to China â a large trade surplus with the US. If the US had capital controls, the capital released by quantitative easing would have stayed in the US and increased domestic investment â and not resulted in the devaluation of the dollar. Chinaâs trade balance in goods and services vis-Ã -vis the world declined from a peak surplus of 9.8 per cent of its gross domestic product (GDP) in the last quarter of 2006, to a deficit of 0.7 per cent in the first quarter of last year. It returned to a surplus of less than 1 per cent in first quarter of this year, due to accelerated shipment of exports to the US in anticipation of higher US tariffs. Correspondingly, Chinaâs current account surplus has also declined from about 9.5 per cent of its GDP in 2007 to less than 0.4 per cent last year. Chinaâs balanced international trade is credible empirical evidence that the yuan exchange rate is neither undervalued nor overvalued. The International Monetary Fund has also found the yuan to be fairly valued. A currency manipulating country would presumably be keeping its exchange rate under equilibrium value to make exports cheaper and imports more expensive, gaining an advantage in international trade. Such a country would have a large and persistent trade surplus vis-Ã -vis the world. A large bilateral trade surplus alone is insufficient to determine whether a currency is undervalued, or a country has been a currency manipulator. In this sense, China cannot be considered a currency manipulator. For the past few years, the onshore yuan exchange rate has more or less tracked the China Foreign Exchange Trade System (CFETS), an international trade-weighted basket of currencies. Global currency markets reeling from US-China trade war The deviation of the yuan central parity rate from the CFETS index has remained within a 2.5 per cent range since July last year, even though the yuan has lost about 6 per cent against the US dollar (from 6.6 to 7.0 yuan). The yuan no longer follows the dollar rigidly because the US accounts for only slightly more than 20 per cent of Chinese international trade. A popular myth about the onshore renminbi exchange rate is that 7 yuan to the dollar is a red line ... There is no evidence to indicate this is official policy If the yuan were to be strictly pegged to the dollar, when the dollar appreciates with respect to other currencies, Chinaâs exports would become more expensive for the customers that account for almost 80 per cent of its market, which makes very little economic sense. Similarly, when the dollar weakens, Chinaâs exports would become cheaper for the majority of its customers, which also makes very little economic sense. Maintaining the yuan exchange rate with respect to a trade-weighted basket of currencies keeps the yuanâs international purchasing power stable. This is in Chinaâs interests and the only way for yuan internationalisation to become a reality. What Trump really gains by calling China a currency manipulator It is definitely not in Chinaâs own interests to use yuan devaluation as a weapon in the trade war. Any significant devaluation in retaliation against US tariffs is likely to be offset by an even higher US tariff rate. Moreover, China will have to pay even more for its imports of agricultural goods, oil and gas, and semiconductors not only from the US but also the rest of the world. A popular myth about the onshore renminbi exchange rate, especially among currency speculators, is that 7 yuan to the dollar is a red line that the Peopleâs Bank of China will defend. There is no evidence to indicate this is official policy. In fact, the renminbi central parity rate rose slightly above 7 yuan per dollar but has stabilised since. An interesting related question is whether quantitative easing is also a form of currency manipulation. My former colleague at Stanford University, Professor John B. Taylor, who served as undersecretary of the US Treasury for international affairs (2001â2005), recently published an insightful book Reform of the International Monetary System: Why and How? Donald Trump wants a weaker US dollar. Bad idea In his preface, Professor Taylor reported the late Dr Allan Meltzer, another eminent economist, as saying that, through quantitative easing, US Federal Reserve Board policymakers have been engaging in âcompetitive devaluationâ of the US dollar. The low interest rate set by the Fed under its quantitative easing encouraged capital to seek higher yields. If the US had capital controls, the capital released by quantitative easing would have stayed in the US and increased domestic investment â and not resulted in the devaluation of the dollar. However, since American capital was free to go anywhere, it drove up the exchange rate of every other currency in the world, driving Japan and the euro zone to launch their own âcompetitiveâ quantitative-easing schemes to counter the devaluation of the US dollar. This is currency manipulation par excellence â a subtle but successful manipulation of the relative exchange rates without direct intervention in the currency markets. Lawrence J. Lau is Ralph and Claire Landau Professor of Economics, Lau Chor Tak Institute of Global Economics and Finance at the Chinese University of Hong Kong