Mnuchin’s right: China’s not manipulating its currency

As a candidate, Donald Trump promised to name China a currency manipulator on his first day as president. Like the declaration to impose a 45-percent tariff, Trump muted his political rhetoric once he took office.

Consequently, the Treasury Department’s semiannual currency reports to Congress, first on April 14 and recently on Oct. 17, both declined to name China a currency manipulator. This was sensible, since China has not manipulated the renminbi in recent years, although it aggressively intervened in the foreign exchange market prior to 2013.

What are Treasury’s criteria for currency manipulation?

Section 701(a)(1) of the Trade Facilitation and Trade Enforcement Act of 2015 (the Act) requires the Treasury secretary to submit a semiannual report to Congress on the macroeconomic and exchange rate policies of major U.S. trading partners.

This act provides additional guidance to the Omnibus Trade and Competitiveness Act of 1988. Under Section 701(a)(2)(A)(ii) of the 2015 act, the report should contain enhanced analysis of any major trading partner that has: (1) a significant bilateral trade surplus with the United States; (2) a material current account surplus and (3) has engaged in persistent one-sided intervention in the foreign exchange market.

Pursuant to the Act, in its first report released in April 2016, Treasury laid down criteria for evaluating these three aspects of a country’s exchange rate policy:

• A bilateral trade surplus with the United States that exceeds $20 billion over the previous 12 months (ending in the middle or the end of the calendar year) will be considered “significant”;
• A global current account surplus of 3 percent or more of GDP will be considered “material” and
• Net purchases of foreign currency, conducted repeatedly, totaling 2 percent or more of an economy’s GDP over a period of 12 months will be considered “persistent one-sided intervention.”

If a major trading partner meets all three thresholds, Treasury’s criteria say that unfair currency practices are at play. The United States will then call out the country and may apply punitive measures.

What happens when a nation is labeled a currency manipulator?

Section 701(b)(1) directs the president (through the Treasury secretary) to engage in bilateral negotiations with countries identified as currency manipulators and urge them to adopt policies to correct undervaluation and significant surpluses.

If within a year of the engagement, the trading partner fails to correct its macroeconomic and exchange rate policies, Section 701(c) grants the president the power to:

• prohibit the Overseas Private Investment Corporation from approving any new financing with respect to a project located in that country;
• after consulting with the director of the Office of Management and Budget and committees of Congress, prohibit federal government procurement of goods and services from the trading partner (with some exceptions);
• instruct the United States executive director of the International Monetary Fund to call for additional rigorous surveillance of the macroeconomic and exchange rate policies of the country; and 
• instruct the United States trade representative to take into account the trading partner’s failure to correct the undervaluation and surpluses when considering bilateral or regional trade agreements.

Of course, a trading partner could retaliate explicitly or implicitly if it thinks that Treasury is not conducting the analysis objectively and the decision hurts its own economic interests.

What about China?

Treasury’s criteria for pronouncing currency manipulation are not the last word. One criticism is the focus, both by Congress and Treasury, on bilateral trade surpluses.

Nevertheless, evaluating China’s currency policy against the three named criteria, China met only the bilateral surplus criterion during the October 2017 reporting period: The economy ran a goods trade surplus of $357 billion with the United States during the four quarters ending June 2017.

With respect to the other two factors, China had a current account surplus of just 1.3 percent of GDP, and the economy conducted net sales of foreign currency totaling 2.7 percent of its GDP over the evaluation period. Consequently, China was only placed on a “watch list” but not labeled as a currency manipulator.

Criteria for currency manipulation defined by other scholars also lead to the conclusion that China has not been manipulating the renminbi in recent years. Consistent with this conclusion, a recent analysis of fundamental equilibrium exchange rates indicates no misalignment for Chinese renminbi.

So why is the notion that “China is manipulating its currency” still widespread? Take a moment to consider recent history. The early 21st century was a decade of unprecedented currency manipulation. Global net official currency flows averaged $1 trillion per year from 2003 to 2013, and more than half of these transactions were excessive, according to Peterson Institute scholars.

Several economies, including China, Taiwan and Singapore, intervened in the foreign exchange market aggressively. China in absolute terms was the champion of currency manipulation during this period. The authorities artificially kept the renminbi weak by acquiring excessive foreign reserves.

In fact, the renminbi was undervalued by as much as 30 percent against the U.S. dollar over the decade of 2003 – 2013. Intervention reached a peak in 2007, when the People’s Bank of China (PBOC) bought an average of nearly $2 billion each business day.

As a result, China’s current account balance reached 10 percent of GDP in 2007. Since the manipulating countries were making excessive net purchases of foreign currencies, the current account balances of non-manipulators continued to worsen. Notably, in 2006, the U.S. current account deficit reached a peak of 5.8 percent of GDP.

The Trump administration puts an unusual emphasis on bilateral trade balances in formulating trade policy. Since China accounts for nearly half of the U.S. global deficit, the once-justified claim that China as a manipulator has resurfaced.

However, the macroeconomic and exchange rate context has changed dramatically in recent years. China’s domestic economic slowdown (from double-digit growth rates to around 6.5 percent) triggered capital outflows: China’s overseas investment surged by 44 percent in 2016.

Correspondingly, China’s foreign exchange reserves dropped by $513 billion in 2015 and another $320 billion in 2016, and the renminbi weakened due to market forces.

Amid fear of further currency depreciation, China has intervened on the opposite direction to support its currency. The PBOC sold substantial amounts of foreign currency in recent years to purchase renminbi, quite the opposite of behavior that would give China an unfair advantage over U.S., European and Japanese firms in international trade.

Any claim that China is now manipulating its currency is misinformed. While China was a currency manipulator in the past and could be a manipulator in the future, it is not a manipulator in the present.

Gary Clyde Hufbauer has been the Reginald Jones senior fellow at the Peterson Institute for International Economics since 1992. He was deputy assistant secretary for international trade and investment policy of the U.S. Treasury (1977–79) and director of the international tax staff at the Treasury (1974–76). Zhiyao (Lucy) Lu has been a research analyst at the Peterson Institute for International Economics since March 2016.