Treasury Bows to Political Pressure, Incorrectly Labels China a Currency Manipulator. Foreign Reserves Decline.
August 8, 2019
Summary: This week the Treasury Dept. declared China to be a currency manipulator, giving in to White House hardliners. The designation is not supported by the facts, has little practical impact, and damages the reputation of the Treasury in global financial circles.
The important part of the US declaration that China is a currency manipulator is not what it means, but how it was done. The term currency manipulator is a formal term for the IMF. As a matter of long-standing practice, the question is a subject of serious, detailed technical analysis by Treasury Research, who make a formal recommendation to the Secretary. That process takes time and its not done by Tweet. This week's action takes the question out of the realm of serious analysis and puts it in the hands of political advisors.
The whole question of whether and how different countries may attempt to influence the value of their currencies is not a simple one because different countries adopt different currency regimes. Some have (or claim to have) floating currencies; some have fixed currencies; and a great number have managed-floating regimes where they use their central bank and regulations to smooth the fluctuations in their currency's value for various reasons. this makes it practically impossible to say with clarity that a given currency has a price that is strictly market determined.
In the case of China, it is especially true because its currency, the yuan or RMB (People's Currency), is not convertible. That means there are laws in China that prohibit or limit the ability of Chinese citizens and Chinese companies to own assets denominated in foreign currencies. In my view, it is nonsensical to ask what is the free market price for a thing that cannot be freely owned and exchanged.
In practical terms, however, it is clear that the Chinese government is very interested in the value of the RMB. This is because China is heavily dependent on the willingness of foreign investors to own domestic Chinese assets. When you visit privately with a Chinese leader, it is clear that they want two things: 1) they want fluctuations in the value of the RMB to be small, 2) they want to avoid situations of systematic, sustained decline in the RMB against the dollar. The reason for the second is clear. Falling currency means rising inflation. Rising inflation is associated with political instability in China's history. They do not want foreign investors to influence domestic liquidity. That's why every major swing in capital flows into China is quickly met with an offsetting change in the required reserve ratio for Chinese banks.
If I had to use a single measure for this complicated question I would choose foreign reserves. If foreign reserves are rising, it likely means that their central bank (PBOC) is selling RMB to buy dollars, which pushes the RMB lower. If foreign reserves are falling, it likely means the PBOC is selling dollar assets (US Treasury Bills) to buy RMB, which pushed the value of the RMB up.
In fact, (chart above) China’s foreign exchange reserves actually fell by $15.54 billion in July to $3.104 trillion, down from roughly $4 trillion in 2015. Translation: the PBOC was selling dollar assets and buying the RMB to support its value, the opposite of US claims. External events, like the Trump Tweetburst last week that the US would impose additional tariffs on Chinese goods, scare global investors into taking money out of China (selling RMB), which drives its value lower. The PBOC, for its part, has been buying RMB to slow down its decline. That's why China's foreign exchange reserves have been falling on trend. It is simply incorrect to say that China has been artificially pushing down the value of its currency.
Ironically, declaring China as a currency manipulator will drive more capital out of China and weaken the RMB further. And it gives the US no real tools to use to counter the decline. The formal declaration simply pushes the two countries to meet at the IMF to have a formal dialog.
My concern is not that is was done, but how it was done. There has been serious debate on the issue inside the White House for the past six months, with the neocon side arguing for this week's action. Rather than use the official Treasury process, however, the action was announced by a presidential Tweetburst on Monday morning. Only later in the day did Treasury Secretary Mnuchin make a statement ratifying the Tweet. That undermines the credibility of the Treasury Secretary among the Finance Ministers of the world. Not a good idea.
Dr. John