The White House would like to label China a “currency manipulator” but doing so would risk harming U.S.-China relations. So, the tone has softened and the tactics have changed. The newly established National Trade Council (NTC), operating out of the White House, is proposing that China not be singled out in the currency war.
Rather, any country found to be lowering the foreign exchange value of its currency to spur exports would be subject to penalties administered by the Commerce Department.
Currency manipulation would be considered an unfair subsidy and U.S. companies that claimed significant harm could petition for anti-subsidy remedies under the proposed change in U.S. trade law. The problem is that the World Trade Organization has never considered currency manipulation to be an actionable subsidy and is unlikely to change its stance.
But there are deeper problems. Anyone who has been following U.S.-China trade relations understands that the NTC’s proposal is really aimed at China. President Trump’s appointment of Peter Navarro — a rabid protectionist and author of the book “Death by China” — as head of the NTC should signal the real intent of the proposed change in tactics. If all countries are treated equally under the currency manipulation measure, then how can China complain?
The new measure would immediately be used against China even though the U.S. Treasury, in its semiannual report, has never labelled China a currency manipulator. Moreover, the IMF announced in May 2015 that China's currency — the renminbi (RMB, also known as the yuan) — was no longer undervalued.
Eswar Prasad, former head of the IMF’s China Division and now a professor at Cornell University, argues that, at present, market forces are more likely moving the RMB-dollar exchange rate than government intervention designed to subsidize exports.
In his new book, “Gaining Currency: The Rise of the Renminbi,” Prasad criticizes the schizophrenic nature of U.S policy — we lecture China to have a more market-oriented exchange rate regime, but threaten to penalize China whenever the yuan falls relative to the dollar, no matter the reason.
In particular, the People’s Bank of China has undertaken policy changes to allow more flexibility in the exchange rate mechanism. In April 2012, the band around the central parity was widened to plus/minus 1 percent, and was further widened to 2 percent in March 2014.
The purpose of doing so was to prevent one-way speculation. From June 2005 to June 2014, the RMB had appreciated against the U.S. dollar, making it easy for speculators to bet on a further appreciation. Adding more flexibility to the RMB-dollar exchange rate would help stem such speculation.
Market forces, however, were at work to lower the foreign-exchange value of the RMB. Slower economic growth, expectation of higher U.S. interest rates and greater uncertainty about the future of China’s liberalization all combined to put downward pressure on the yuan.
Beijing recognized those forces and, on Aug. 11, 2015, unexpectedly devalued the RMB relative to the dollar by nearly 2 percent. The PBOC also gave the market more play in setting the so-called daily reference rate (i.e., the opening RMB-dollar exchange rate or “central parity”).
The sudden devaluation shook the markets as speculators began to sell yuan. The RMB continued to fall relative to the dollar (it declined by another 2 percent in the two days following the official devaluation), and the PBOC had to reverse course by intervening to prop up the yuan. Since then, China has burned through nearly $1 trillion of its foreign exchange reserves to defend the yuan.
During 2016, the yuan fell by 7 percent against the dollar. The expectation of further depreciation has led to large capital outflows as people and companies flee the RMB, even in the presence of tight capital controls.
There is no doubt that even though the depreciation of the yuan reflects market forces, the NTC would be inclined to label China a currency manipulator under the proposed rule change.
Special interest groups favoring protectionism would jump on the band wagon and demand remedies. China would no doubt point to the manipulation of interest rates by the Fed as a form of currency manipulation and turn to the WTO to resolve the dispute.
The politicization of exchange rate policy would continue to divert attention from China’s success in liberalizing trade since 1978, when only a few state-owned enterprises had trading rights and tariff and nontariff walls were high.
The difficulty of determining whether exchange rates are falling due to deliberate intervention to spur exports or because of market forces means the new policy, if implemented, would cause confusion, promote protectionism, and flame nationalism. It is a flimsy basis for confronting a major trading partner like China.
Instead of employing new tactics to improve U.S.-China relations by generalizing currency-manipulation policy to all countries, the U.S. should be thinking of how to encourage China to further liberalize its institutions and let markets be the primary force in setting the RMB-dollar exchange rate.