Digging Deeper podcast | Explained: Currency manipulation and China

In his usual subtle style, Donald Trump was indicating that China had devalued its currency, the renminbi, and let it drop below the 7 mark against the dollar, dropping to its lowest level in 11 years. As the BBC explained, “A weaker yuan makes Chinese exports more competitive, or cheaper to buy with foreign currencies.”

On this episode of Digging Deeper, we look at this currency manipulation saga.

So what’s all this manipulation drama?

Some background here. In 2015 - a time when polls indicated Hillary Clinton would win the 2016 elections by a landslide and Donald Trump was, to quote comedian Seth Meyers, “running as a joke” - Trump made a remark that was lost in the bombastic outrage that would engulf his campaign. A few months after he launched his campaign for the presidency, he wrote in an opinion piece that one of the first things he would do, on day one as President, would be to label China a currency manipulator. He didn't, and he failed to follow through with a threat to apply the label in his first 100 days.

The latest round of the US-China tiff kicked off on August 1 when Trump, upset at the lack of progress at trade talks in Shanghai, took to Twitter to pledge additional tariffs on imports from China. From September 1, he said, Washington would levy a 10 per cent tariff on US$300 billion of thus-far-untouched imports. The following Monday, China allowed the yuan’s exchange rate to weaken through the psychologically significant 7 yuan to the dollar level for the first time in a decade. Hours later, the US Treasury declared China guilty of currency manipulation, something it had held back from doing for a long time.

According to Nikkei Asian Review, “At no stage in Trump's presidency has China, or any other country, met the technical criteria required for a formal designation as a currency manipulator. However, on Aug 5, the People's Bank of China -- which has been supporting, rather than weakening its currency for the past few years -- allowed the yuan to slip below 7 yuan to the dollar, a threshold that has remained in place for more than a decade.” China’s central bank played down the significance of the move, saying the threshold was "not a dam" that, having been broken, would not be rebuilt. It said, the threshold "is more like the level of a reservoir ... it is normal for it to rise and fall." 

Hui Feng, a senior research fellow at the Griffith Asia Institute in Australia, claimed that China was reluctant to let the yuan depreciate. However, it was forced by the impact of escalating tariffs on exports to USA. He explained, "Beijing has implemented a controlled depreciation whenever a new round of tariff hikes was announced, and I don't see any difference this round."

Well, from Donald Trump’s tweet, it is pretty clear he saw it as out of the ordinary. He even tweeted for effect, “Are you listening Federal Reserve?...This is a major violation which will greatly weaken China over time!"

It was then that the Treasury Department, at the behest of Donald Trump, officially designated China a “currency manipulator”.  

It must be noted that there have been calls over the years - mostly from the left wing of the Democratic Party but also sporadically from Republicans like Mitt Romney - for the Obama administration to officially designate China as a currency manipulator.

Let’s examine what this means. According to a report by Vox, the “manipulation designation is a response to China’s decision to reduce the value of its currency. That, in turn, was a response to Trump’s decision to levy tariffs on a broader range of Chinese goods. That was the result of a breakdown in trade talks in May. And the whole conflict represents two different things tangled together — on the one hand, a growing belief on the part of a wide swath of the American establishment that it’s time to take the US-China relationship in a more confrontational direction, and on the other hand, Trump’s...personal beliefs about trade in general.”

A less sympathetic view was expressed by CNBC. Their report said, “The onshore yuan fell to levels not seen since February 2008... and the offshore yuan dropped to its weakest since it began trading in the international market around 2010. The recent escalation in trade tensions left analysts and investors wondering how much further Beijing would allow the currency to weaken.”

Yes, allow. Here’s why.

How China controls its currency

Unlike other major currencies such as the US dollar or the Japanese yen, which have a free-floating exchange rate, China maintains strict control of the yuan’s rate on the mainland. Every day, the People’s Bank of China sets something called a daily midpoint fix, based on the yuan’s previous day closing level and quotations taken from inter-bank dealers. China’s central bank also manages the country’s  complex monetary policy. As CNBC explains, the yuan is allowed to trade within a narrow band of 2% above or below the day’s midpoint rate. If it deviates too much, according to some market watchers, the central bank steps in to buy or sell the yuan, putting a lid on its daily volatility. This exchange rate is known as the onshore yuan, or CNY. China’s central bank, which is, unsurprisingly, heavily influenced by the government, sets the daily midpoint to provide direction to the market and guide the currency. The tightly managed onshore yuan has weakened about 4% against the dollar in August.

What is the value of the yuan within China? According to the Vox report, one thing the Chinese government did was keep its currency “artificially cheap. That meant Chinese people had less purchasing power to buy foreign-made goods, and that foreigners could (buy) Chinese-made goods more cheaply. It was, in effect, a tax on Chinese workers that served to subsidize Chinese export-oriented factories. The purpose of the policy was twofold — to avoid falling into a recession during the global financial crisis, and to help China build up its long-term industrial capacity. The cheap exchange rate policy was not necessarily a good idea. It had the impact of keeping the bulk of the citizens of what is still a relatively poor country artificially poorer. But it did “work” in the sense of achieving its main objectives.”

There is also something known as the offshore yuan - that trades mostly in Hong Kong as well as in Singapore, London and New York. The offshore yuan is not strictly controlled. Market supply and demand influence the offshore yuan’s exchange rate, but volumes traded are comparatively smaller. Experts say PBOC wants to keep the spread between the onshore and offshore yuan narrow since they are technically the same currency. CNBC explained that when “the offshore rate deviates too far from the onshore figure, the central bank will intervene to dampen volatility and prop up the currency using its vast foreign-exchange reserves, which was more than $3 trillion as of July. The PBOC also relies on state-owned banks to enter the offshore market and swap dollars for yuan.” To prevent this offshore yuan from depreciating too fast, PBOC issues short-term yuan-denominated bills in Hong Kong that essentially mop up liquidity from the market and raise borrowing costs for the yuan, making it more expensive for people to short the renminbi. (Renminbi is the official name of the yuan.)

Though China really did indulge in a fair bit of currency manipulation between 2003 and 2013-14. However, by the end of the Obama administration, the situation had reversed. Chinese people were trying to take financial resources out of that country, which was putting downward pressure on the value of China’s currency, and the government was intervening to stop that. With the Trade War since March 2018, Trump’s policies have hurt Chinese export-oriented businesses. That’s put further downward pressure on the value of the yuan.

So what did the most recent devaluation do? The Chinese government, unlike earlier, did not step in to prop up the currency. It is not going down because the Chinese are trying to defy Trump - it is dropping because Trump is trying to stick it to them.

The PBOC claimed the slump in the yuan was driven by "unilateralism and trade protectionism measures and the imposition of tariff increases on China".

What does the designation mean?

The New York Times reported that twice a year, the US Treasury Department releases a report that analyzes whether countries are manipulating their currencies. In May of this year, it criticized China’s practices but said China met only one of several criteria for determining whether a country was a manipulator.

NYT added that, according to Eswar Prasad - a former head of the International Monetary Fund’s China Division - the US govt was applying the label in an “arbitrary and clearly retaliatory manner.” In a report released in July, the IMF. also found that China’s currency was broadly where it should be.

At this point, growing opinion indicates this is largely symbolism. As the BBC report explained, “The move is largely symbolic because the US is already engaged in trade discussions with China and has implemented tariffs on the country's imports. However, it fulfils a presidential campaign promise by Mr Trump who pledged to name China a currency manipulator on his first day in office.”

As for China’s move to let the yuan drop, Stephanie Segal, a senior fellow at the Center for Strategic and International Studies, told NYt, “China’s willingness to allow the currency to depreciate was likely intended to remind the president of the downsides of escalating actions...If that was the idea, it didn’t have the desired effect.”

Wait, so nobody wins?

Michelle Fleury, a New York business correspondent for BBC, wrote, “The move doesn't change much. Not legally speaking. But it is a big deal, accentuating just how fast things have gone south between the two largest economies. When the US Treasury labels a country a currency manipulator the next step would normally be for negotiations to begin between the two countries. In this case, trade negotiations have already been going on for more than a year. The process also opens the path for America to introduce tariffs. Again, that's already happening as part of Mr Trump's 'America First' approach to trade...Nobody thinks this will increase the odds of a compromise by the Chinese side when it comes to trade.”

Meanwhile, US Treasury Secretary Steve Mnuchin said, “China has a long history of facilitating an undervalued currency through protracted, large-scale intervention in the foreign exchange market...In recent days, China has taken concrete steps to devalue its currency, while maintaining substantial foreign exchange reserves despite active use of such tools in the past.”

He added that the US will engage with the International Monetary Fund "to eliminate the unfair competitive advantage created by China's latest actions".

As the Vox analysis explained, the claim is that China could be doing more because it has substantial foreign currency reserves to prop up its currency. Even if true, this seems irrelevant on the merits to a manipulation claim. What’s more, many China experts believe this is untrue. Their take is that China is allowing its currency to devalue because the Chinese government is running out of dollars. Or, as economist Christopher Balding tweeted, “China is very squeezed for USD.”

The more difficult the United States makes it for Chinese exporters, the more China’s currency needs to go down and the worse living standards become for the average Chinese person. That’s how the trade war puts pressure on China. So, it is possible Trump understands this perfectly well and is just trolling the Chinese government. However, it is also possible that the move reflects him having little idea of what the fallout is. Should Trump fail to get re-elected, one thing that will define his presidency is that he is obsessed with bilateral trade deficits. One of  election campaign pitches was that  the United States was “losing” hundreds of billions of dollars every year to trade partners.

So are things going to get much worse? Economy wise, perhaps not. As Tom Holland wrote in his column in the South China Morning Post, “Chinese policymakers briefly stopped manipulating the exchange rate of the yuan, and within 24 hours the United States had turned around and formally designated them currency manipulators – a designation Beijing has long been anxious to avoid, and that Washington has long withheld from making.”

At the individual level, it could change a few things. Holland explains with the help of T-shirt prices, “ a three-pack of cotton T-shirts imported from China that sells in an American mall for US$10...Those T-shirts are typically imported for around US$4 a pack, the other US$6 covering domestic US distribution marketing and retail costs, as well as the retailer’s profit. A 25 per cent tariff would push the import cost up to US$5 a pack, and - if fully passed on to customers - would bump the retail price up to US$11.00, That’s a noticeable increase. It’s big enough potentially to have a negative impact on US consumer sentiment in the run-up to next year’s US presidential election.” 

According to Holland, the real significance of this spat is not the near-term effects it might have on trade, or even on the currency markets. It makes a meaningful deal on US-China trade relations highly unlikely this year, or indeed before the 2020 US presidential election.