The latest round of tariffs on $300 billion of Chinese goods imposed by Trump last week has seriously rattled world markets. The Chinese currency has now depreciated against the dollar, sending stock markets into a tailspin. Trump immediately blamed China for "currency manipulation," and our craven Treasury Secretary Steven Mnuchin then violated the Treasury's own guidelines by formally designating China as a currency manipulator in order to keep in step with his intemperate boss.
The only economic manipulation here is Trump's. His tariffs have caused gratuitous and serious damage to the US economy, the world economy and the global trading system.
The Chinese currency has now weakened in the offshore market close to the psychologically relevant rate of 7.0 yuan per US dollar, with the offshore currency rate on Tuesday at around 7.05 yuan per dollar. As China's currency weakens (with one dollar buying more yuan), China's exports gain competitiveness relative to US goods and services. There was nothing magical about the 7.0 threshold except for the fact that China had implicitly resisted its currency weakening beyond 7.0 in the interest of closing a trade deal with the United States.
"The only economic manipulation here is Trump's. His tariffs have caused gratuitous and serious damage to the US economy, the world economy and the global trading system."
The weakening of China's currency therefore conveys three pieces of information. First, it strengthens the view that no trade deal is likely in the short term. Second, it suggests — consistent with a multitude of evidence — that China's macroeconomy has suffered as the result of the US tariffs. Third, it suggests that China will let its currency continue to depreciate in order to help stabilize China's trade and overall growth.
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It does not suggest, except in Trump's imagination and the Treasury's outlandish claim, that China is manipulating its currency. This is true even according to the arbitrary standards of America's own trade laws, much less according to objective standards. According to the US Treasury's own criteria before Monday's pronouncement, a country may be considered a "currency manipulator" if three tests are met. First, the country has a significant bilateral trade surplus with the United States of at least $40 billion. Second, the country has a material current account surplus overall of at least 2% of GDP. Third, the country has been consistently intervening in the foreign exchange market to keep its currency weak, with an accumulation of foreign exchange reserves of at least 2% of GDP over the preceding six to 12 months. In China's case, only the first of these three criteria is met.
On the second test, China's current account surplus is around 0.4% of GDP, according to the IMF data, far less than 2% of GDP. In fact, China's current account surplus as a share of GDP has been declining for the past four years, from 2.7% of GDP in 2015. There is no sign China is attempting to expand its current account surplus through currency manipulation.
On the third test, China has not been accumulating foreign exchange reserves in recent years. In fact, China's reserves have been stable at around $3.1 trillion for the past two years with slight ups and downs. By the Treasury's criterion, China would have had to engage in one-sided foreign exchange interventions to accumulate increased reserves by around $288 billion (2% of China's $14.2 trillion GDP in 2019). No such accumulation is in sight.
For these reasons, the Treasury acknowledged in its report in May 2019 that China does not meet the criteria of a currency manipulator. The Treasury's reversal yesterday is arbitrary, just as Trump's imposition of new tariffs against China was last week.
Nor is there any reason to believe that the yuan is undervalued at its new offshore rate of around 7.05 per dollar. In fact, if we examine the trade-weighted real exchange rate of the yuan (the currency value taking into account China's price level and the price levels of China's trading partners), the yuan actually appreciatedby around 20% from June 2009 to June 2019, and by around 6% from June 2014 to June 2019. The currency has been nearly stable in both nominal and real (price-adjusted) terms over the past two years. There is nothing at all to suggest any unfair currency manipulation by China.
Moreover, there are many market-based reasons for the yuan to weaken in light of Trump's tariffs. China's economic growth is slowing, and its exports are hurting. Market forces would tend to weaken the yuan as the demand for China's exports has weakened and as China's credit market conditions have eased given the lull in China's growth. From a policy point of view, China's macroeconomic authorities should welcome the decline in the yuan, as the declining exports to the United States will be partly offset by greater competitiveness in other markets. Such a partial offset is not nefarious — it simply helps cushion a harsh blow from the United States.
Viewed objectively, the US standards on currency manipulation are arbitrary. There is nothing in economics that should require China to run a bilateral balance with the United States (that is, to export the same value as it imports, no more nor less). In fact, the United States runs a bilateral deficit with most of its major trading partners, not because it is doing something unseemly but because the United States saves less than it invests. This is because of the huge US budget deficit, now around 4% of GDP. When it comes to national profligacy, we are our worst enemy, not China, the EU, Mexico or Canada. The other criteria — the magnitudes of the overall current account balance and foreign exchange accumulation — are also arbitrary.
Trump can't wrap his mind around international trade. International trade is based on mutual gain, not on winners and losers. China, the United States and the European Union all gain from an open trading system, and Trump's protectionist policies represent the biggest threat to that open system in modern times. To the extent that some US workers are hit hard by trade, income support from the federal government and support for retraining are vastly better answers than breaking apart the international trading system. To the extent that trade rules should be tightened or revised on complex 21st century topics such as industrial policy, intellectual property, state aid and state-owned enterprises, the rule-based World Trade Organization is the place to proceed, not unilateral US protectionism.
When Trump launched his trade wars last year, he boasted, "Trade wars are good, and easy to win." Far from achieving new trade agreements with China and the EU, Trump has undermined business confidence and cross-border investments. Trade wars are bad, and easy to lose. In fact, everybody is losing. It's time to end Trump's serious trade blunders.