- China is not a currency manipulator because it does not fit the US Treasury’s own definition of what a currency manipulator is.
- There is a difference between a country managing its currency, and manipulating it.
- And China’s slight devaluation is a clear case of crisis management, not retaliation.
On Monday, China allowed its currency, the yuan, to depreciate to a level unseen in decades – 7 yuan to $US1.
The world of finance immediately panicked. Stock markets went red around the world, and here in the US – increasingly the best house in a bad global economic neighbourhood – the Dow fell 767 points, handing Wall Street its worse day of 2019.
This was a disruption to be sure, and the Trump administration – never wasting an opportunity to be as aggressive as possible – responded by declaring China a “currency manipulator.”
The problem with that is that China is not a currency manipulator – at least not by the US Treasury’s (UST) own definition of what a currency manipulator is, and certainly not based on the action it took this week.
According to the UST a country is a currency manipulator when it does the following three specific things:
- A significant bilateral trade surplus with the US.(Check! China’s got that.)
- A material current account surplus of more than 3% of GDP.(China does not have that.)
- Persistent one-sided intervention in its currency market.(China’s move on Monday doesn’t fit this bill, so no.)
So technically, China isn’t a currency manipulator. What, then, is the Trump administration’s problem? Ask any economist and they will tell you that Trump’s trade war is having its desired intent. China’s economy is slowing, it’s selling fewer exports, and so it makes sense that there is downward pressure on country’s currency.
In fact, China had been supporting its currency – actively keeping it above 7 yuan to the dollar – since around March of this year. It did this to show the world that it could keep things stable despite Trump’s aggression and some ugly domestic economic issues once again bubbling to the surface at home.
Stuck in the past, as usual
Trump called China a currency manipulator because Trump’s understanding of China’s currency is about five years behind reality.
A few years ago, China’s economy was more dependent on cheap exports, and it needed a weak currency to sell them all over the world. But since then China has tried very hard to evolve. Policymakers have been trying to move its economy away from exports and toward a more consumption based economy like the United States.
To do that, though, your people needed to have a stronger currency. And so policymakers have had to try to strike the balance between a currency weak enough to sell exports, and strong enough to support a rising Chinese middle class.
Bloomberg Chief Economist Tom Orlik tweeted out one chart that illustrates this point. It shows China’s currency reserves declining majorly around 2014. That’s because China started using those reserves to buy back yuan in order to support the currency’s price.
China currency manipulator tag is about five years too late… pic.twitter.com/NlF1cR8gpw
— Tom Orlik (@TomOrlik) August 5, 2019
Now I know what you’re thinking: “Linette, isn’t this in itself a currency manipulation?”
No, because yet again, China does not have all three characteristics of a currency manipulator.
And no, because – as the wonks at the International Monetary fund and the traders on Wall Street will tell you – a stable yuan makes for a more stable world.
Retaliation or crisis management?
You’re going to hear people say that this yuan move down was China’s way of retaliating against the US for the trade war, but that’s not what’s going on here.
The reality of this situation is that the market has been pushing the yuan to this 7 yuan to $US1 level for some time. Screeching past it was a tiny, but psychologically important move because it told the world that China could no longer support its currency at that level.
It told the world that Trump’s trade war – coupled with China’s own domestic economic issues – has become a powerful destabilizing force, one that is pushing Chinese policymakers to make uncomfortable decisions about the country’s economy that it would not otherwise make.
A move like this doesn’t come without risk. Back in May when trade negotiations first started falling apart in ernest, Business Insider spoke to Charlene Chu of Autonomous Research, one of the best Chinese credit analysts in the game. She warned that if things got really bad and the yuan started to slide, China’s policymakers might be unable to stop it.
“If the yuan crosses through 7, 7.2, 7.4 [per dollar]… believe that global markets will start freaking out,” she warned. “Asian currencies will start moving, global equities will be tanking, bond yields will spike, the whole world will feel this.”
As we learned the last time China devalued its currency in 2015, a lower peg means people start taking their money out of the country – it means currency outflows. That year $US500 billion left China, according to the International Institute of Finance.
“That’s the panic that makes the market drive it [the yuan] lower,” Chu said.