Let Slip the Dogs of Currency War
Five questions about the yuan.
This week, the People’s Republic of China let slip the renminbi (RMB). For years, when measured against the dollar, the RMB had generally either strengthened or held steady. Then, this week, it dropped, falling 1.9 percent against the dollar on Tuesday, and another 1.6 percent on Wednesday.
Active debates are raging among economists and China watchers about what it all means. Assessments shift with each day’s observation of China’s central bank (a sample size of two). With that caution, here are five questions and some tentative answers about what it all means:
Was this move Chinese currency manipulation?
There were certainly accusations of currency manipulation in the wake of China’s move. To attempt an answer, though, we need some clarity on what “currency manipulation” means. Setting aside legal definitions and focusing on economic substance, one simple definition might be that a country manipulates its currency when it intervenes in foreign exchange markets. That’s really too simple a definition, though. It would indict any currency approach other than a pure float, which is when private buyers and sellers alone determine a currency’s value.
Usually, advocates for stronger action against currency manipulation include some context that considers motive. Was the country running a trade surplus? Did it accumulate foreign exchange reserves? Did it intervene to weaken its currency to make its exports appear cheaper? All might be damning indicators.
China is running a trade surplus of some 2 percent of GDP, versus 10 percent of GDP in 2008. That’s within the bounds of what is generally considered normal (no serious economist thinks that every country should have perfectly balanced trade every year). On the other criteria, though, the context seems more exculpatory for China. While China had previously accumulated a mountain of foreign exchange reserves, its roughly $3.7 trillion stockpile had decreased by $150 billion in the first half of 2015. That would indicate that there were more people in the market trying to turn RMB into dollars than the other way around (at the given exchange rate). China met that extra demand by depleting its stock of dollars. That would seem to support an argument that the market was pressing for a weaker RMB.
China claimed that it was cutting back on its intervention and allowing the market to do what it would. It was not moving to a free float, but would allow its reference rate on the currency to move to reflect market pressures. In support of that claim, when China intervened on Wednesday, it was to stop the RMB from falling further (it was buying RMB to try to make the currency stronger).
Given the potentially subjective element of determining which actions are permissible in currency markets and which imbalances exceed normal levels, one common approach is to turn to the International Monetary Fund for a more independent assessment. In this case, the IMF offered a cautious blessing, saying China’s new approach was “a welcome step as it should allow market forces to have a greater role in determining the exchange rate.” Like everyone else, though, the IMF is waiting to see how this plays out in practice.
Is this bad for the United States?
I now recognize the temptation that all journalists must feel these days — go with a colorful Trump quote! I, too, succumb: Donald Trump said on Tuesday that China’s move would be “devastating” for the United States.
Enough of that. More seriously, for over a decade the challenge for the United States has been to decide what kind of currency regime we want China to have. That does not mean that Beijing will take dictation on the matter, but it gives us a reference point: if China’s actual practices deviate from our ideal, we may have cause for complaint.
I have detailed the various possibilities elsewhere, but what China is doing this week is pretty close to what the Bush and Obama administrations have asked it to do for years — move towards a market-determined exchange rate. Some advocates thought such an approach would boost demand for U.S. exports and lessen competition from Chinese imports. The call for adherence to market forces was also supposed to address concerns of fairness. When we were asking, there was a presumption that the market would push the RMB ever upwards. But markets can be fickle that way. We got the policy we wanted, but not the export boost.
If China ultimately decides to only let the RMB ratchet downwards, we will have cause for complaint. For the moment, though, China is doing what we have asked.
Why is China doing this?
China’s motivation is the subject of the most intense debate. There are at least three potential explanations: a desire to help exporters; a desire to elevate the RMB’s status at the IMF; or a desire to advance market reforms. The savviest commentators have noted that heterogeneous views among Chinese policymakers could mean that any or all of these factored in. For the moment, these motivations align.
The most troubling part, though, is that the move clearly came in the context of worrisome economic news from China. Last month, China’s stock market dropped sharply. Over the weekend, it was reported that Chinese exports were down 8.3 percent from July 2014. The first bit of news might cast a damper on expectations of enthusiastic Chinese consumers spurring domestic demand (though China’s market is not as connected to the rest of the economy as most of those in the developed world). The second bit of news cast a damper on hopes that growth would come from abroad.
One of the quirks of following the Chinese economy is that the data is often unreliable. The effect, then, is like trying to figure out what’s showing on a movie screen by only observing audience reactions. By this measure, the situation looks bad. China’s leaders appear to be curling up in their seats, covering their eyes, and choking on their popcorn.
Is China turning to the market?
China says it is. It knows that such claims play well with a Western audience. President Xi Jinping made much of a reliance on markets when announcing his reform agenda in 2013’s Third Party Plenum. In practice, however, that has not turned out to mean a diminution in the role of state-owned enterprises. Again, we’ll have to wait and see.
The difficulty lies with China’s position as a part-time marketeer. With the stock index, Chinese leaders seemed fine with letting the market determine the direction, so long as the direction was up. When the direction turned down, the government intervened heavily. That leaves the government in a tenuous position: having once overruled the market, it’s difficult to invite everyone back in to go about their business. We could see something similar in currency markets.
Is this the start of a currency war?
Since the start of the global financial crisis, devaluations have been accompanied by warnings of currency war. The fears harken back to the Great Depression, when countries would try to swipe demand from each other through competitive devaluations. Those fears have emerged once again.
While the concept is dramatic, it is harder to see it in practice. In part, this is because there is no useful distinction between monetary policy and currency policy (one of the difficulties of attacking currency manipulation). Brazil’s then-Finance Minister, Guido Mantega, issued a currency war warning in 2012 when the Fed launched its third round of quantitative easing.
China, fearful of a slowdown, cut its interest rates four times in the last year. The latest move just accommodates the resulting desire to move money out of China and toward countries with higher rates of return. While commentators tend to see competing devaluations as troubling, they often herald coordinated monetary easing as useful policy coordination. There is a problematic inconsistency there.
It’s hard to know what behavior would actually constitute a currency war. This week’s move by China is just another instance of a country pursuing its economic interests. The unusual part is that China, so far, is doing so by complying with previous demands from the United States and the IMF.
Photo Credit: China Photos/Getty Images News