Is China the great currency manipulator as Trump claims?

by: John Gray

If Donald Trump has said it once, he’s said it a dozen times, “China will be on notice that America is back in the global leadership business and that their days of currency manipulation and cheating are over.”

Currency manipulation — a topic discussed often in Washington, D.C. — occurs when countries intervene in the markets to devalue their currencies. The nation’s goal in reducing its currency is to reduce the cost of goods, thus increasing exports to the United States. This is particularly the case with China.

Yet, the topic is far more complex than the simplistic narrative used by politicians. While China does engage in some forms of currency manipulation, an equally important debate is whether the U.S. is an even worse actor.

Perhaps no one has documented this topic better than James Rickards, author of “Currency Wars: The Making of the Next Global Crisis.” The argument against China is based on their monetary policy, which pegs the value of the Yuan to the U.S. dollar. Critics have long maintained that China uses an artificially low peg, resulting in cheap goods.

However, it’s important to truly understand how China’s system works. The yuan is not a floating currency like the U.S. dollar or the euro; it doesn’t trade freely as those currencies do. Instead, the Chinese closely control the yuan, and its ability to settle transactions is tightly regulated by China’s central bank.

Americans buy goods from Chinese sellers with U.S. dollars. But when a Chinese seller receives those dollars, he is forced to deposit them in the Chinese central bank in exchange for yuan at a fixed rate. Inversely, when a Chinese buyer wants to purchase American goods, he must request dollars from the central bank — where they are provided just enough dollars to purchase those goods. The strict control of the supply of yuan and dollars allows China to control their peg to the U.S. dollar, which is currently 8.11 yuan per U.S. dollar.

In effect, because China’s monetary policy must remain bound to the dollar to preserve its link, Federal Reserve policy becomes the de facto monetary policy for China. If China utilized its own monetary policy, as I’m sure it often would like, the yuan’s peg to the dollar would fail. After all, China’s only mandate is to engage in a coordinated dance with the dollar. As Rickards points out, that process actually leads to a number of unintended consequences for China, perhaps far more than it does for the U.S.

For example, starting in the early 2000s, but particularly during the economic recession, the Federal Reserve responded to the crisis and deflation fears by pumping trillions of dollars into the economy, using low interest rates and quantitative easing (QE) (which is just printing new money to buy government debt). Those newly printed dollars began to flow into China to purchase more goods.

As more dollars flowed into China, it essentially tied its hands, providing it no option and to print more yuans to soak up all the dollars flooding the country.

As Rickards writes,

The more money the Fed printed, the more money China had to print to maintain the peg. China’s policy of pegging the yuan to the dollar was based on the mistaken belief and misplaced hope that the Fed would not abuse its money printing privileges. Now the Fed was printing with a vengeance.

The Federal Reserve was printing new money like crazy, but the downtrodden U.S. economy wasn’t moving (velocity of money) enough to create inflation. Instead, the Fed’s policies led to massive inflation in China. The more dollars they received, the more yuan they printed. Inflation was exceeding five percent annually, leading to a real increase in the price of goods for Chinese goods. In some ways, U.S. policy was revaluing the yuan.

In other ways, the U.S. has a far easier — and more often used — ability to manipulate the dollar for our own benefit. Actually, the rest of the world views the U.S. as one of the worst currency manipulation violators.

In May, the U.S. declared five countries currency manipulators: China, Japan, Korea, Taiwan, and Germany. Yet, even CNBC thought the U.S. was hypocritical, writing:

To be sure, the U.S. could find itself in a tenuous position due to its own monetary practices. Quantitative easing became popular on a global scale after the Federal Reserve enacted three rounds of QE that ballooned its balance sheet to $4.5 trillion. The dollar index, which measure the greenback against a basket of global currencies, declined as much as 18 percent peak-to-trough during the easing program 

Yes, folks, that is the definition of currency manipulation — right here in the good ‘ole U.S.

But, when it comes to China, not only has the Fed engaged in a monetary policy that has lowered the value of the U.S. dollar for economic purposes, but it has also been able to manipulate the very currency — the yuan — that we complain about. In fact, in the war of economics, China’s peg appears to be a weakness the U.S. utilizes in unleashing skyrocketing inflation across China.

An equally important question, however, is whether China’s devalued currency is really bad for Americans. In fact, it’s much worse for the Chinese. A currency that is devalued also lowers the value of the output by the workers and capital in that particularly economy. As the Cato Institute writes,

It [China] will, in effect, be selling its exports for less than their true economic worth, thus transferring wealth to the United States. People in this country experience meaningful increases in their standards of living at the expense of the country that has devalued.

American like cheaper goods. If we can purchase more goods with our paychecks, that’s generally a good thing.

Think of it this way: When China artificially devalues their currency, it acts much like a rebate for Americans. Instead of a Chinese producer receiving a good at the higher, fair value, they must sell the good at a lower cost. At the same time, America gets the product at a price that is cheaper than it otherwise might be.

Yet, it becomes political when those cheaper goods conflict directly with American-made goods. However, as Cato points out, trade mechanisms are in place that should deal with any products that are artificially low compared with domestic products.

U.S. trade laws allow industries to challenge countries with anti-dumping or countervailing duty laws where they believe unfair competition is hurting domestic producers. And in fact, as Cato argues, trade remedies are a better way to deal with currency manipulation. Instead of attacking a country that is a currency manipulator, thus leading to an increase in price in all goods, trade laws can address specific items where a problem exists.

At the end of the day, this is not about defending China’s practices. It’s about recognizing that we should be cognizant of our own. The Federal Reserve has engaged in one of the most dynamic and experimental monetary policies, perhaps ever. Like many things, challenging China for currency manipulation sounds like smart populist rhetoric, but we better be aware of how our own country is participating in that policy. And perhaps just as important, we should be aware of any outcomes that may result in a revalued yuan — certainly from our wallets’ perspective.

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