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US Treasury gets China largely right

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After Trump huff and puff, a renminbi non-event

By Mark Sobel in Washington
Note: From 2000-14, the author, now US chairman of OMFIF, was actively involved in the US Treasury’s preparation of its semi-annual foreign exchange report.

Unsurprisingly, with fanfare not seen for years, all eyes have been riveted on the US Treasury’s autumn foreign exchange report, published on 17 October. President Trump has accused China of currency manipulation, and stated he’d look at the ‘formula’ for ‘manipulation’ * in the semi-annual document.

Well, now it’s out. Despite much huffing and puffing about China – Trump told Reuters in August, ‘I think China’s manipulating their currency, absolutely. And I think the euro is being manipulated also’ – the report is status quo. The substance is unsensational, and little changed from the last report in April. Once again, there is no ‘manipulation’ finding.

Treasury Secretary Steve Mnuchin and the Treasury staff got the main conclusions largely right. One can always quibble here and there. But in general, the report does a good job. The global and country analyses are again of high quality.

The Treasury recognises that China’s current account surplus is now relatively small. (Yi Gang, People’s Bank of China governor, said in Bali on 14 October that the country ran a current account deficit in the first half this year, although it may have a small surplus for the whole year.) The Treasury also accepts that China, if anything, has been intervening to prop up the renminbi. Hardly the behaviour of a currency manipulator.

There is a lengthy section on the Chinese economy, including the history of external and exchange rate developments. The report correctly recognises that state intervention should be reduced to allow a greater role for market forces; macroeconomic reforms are needed to support greater domestic consumption and reduced saving.

The Treasury goes out its way to focus on China’s large bilateral surplus with the US. Economists dismiss the relevance of bilateral balances. But the Treasury is required by statute to focus on them and doing so is inevitable given the President’s views.

The Treasury rightly concentrates on Germany and its eye-popping, excessive current account surplus. Alas, Germany doesn’t have its own currency, and the surplus is due to excessive saving, which is the real issue to tackle. The Japanese discussion is straightforward — despite Japan’s large current account surplus, it has not intervened for years and policy is highly accommodative. Korea garners much attention for its large current account surplus and undervalued currency.

One failing is glaring. The Treasury doesn’t admit that the dollar’s generalised strengthening – mirroring relative US cyclical strength, Fed policy normalisation, an ill-timed fiscal expansion and quantitative tightening, all underpinning US rates — will increase the US current account deficit and corresponding surpluses elsewhere. Nor does it acknowledge that US trade rhetoric and measures against China weaken the renminbi and other emerging market currencies.  Rather than admit heavy US responsibility for these currency developments, the Treasury takes aim at renminbi depreciation and reiterates Mnuchin’s unsubstantiated concerns about competitive devaluation.

Since 2016, using its ‘enhanced analysis’ framework – the President’s so-called ‘formula’ – the Treasury has put forth a ‘monitoring list’. This looks at whether countries have large bilateral surpluses (above $20bn) with the US, material current account surpluses (above 3% of GDP), and persistent one-sided intervention (net currency purchases of above 2% of GDP over a 12-month period).

The list is useful in focusing attention on countries’ currency practices and macroeconomic policies — even if there is no ‘manipulation’. But the list’s usefulness is compromised. Initially, the ‘monitoring list’ singled out countries that met two of the three criteria. However, China now meets only one of the criteria – a large bilateral surplus with the US.  Nonetheless, the Treasury keeps China on the list because it constitutes a ‘disproportionate share of the overall US trade deficit’. This is a fudge, though perhaps a small one.

India somehow found its way onto the list, despite having a current account deficit. What kind of a mercantilist runs a current account deficit? Taiwan also escapes sufficient scrutiny – it is off the list despite a double-digit current account surplus and a history of massive intervention.

For over a decade, media and Congress have been questioning whether the next Treasury report would designate China a ‘currency manipulator’. This is the wrong question on two counts.

First, while there was an intellectual case perhaps 12-13 years ago for designating China this way, there clearly hasn’t been one lately – either for China or other major trading partners, as acknowledged in the report’s executive summary.

Second, even if a country case for ‘manipulation’ is weak, harmful currency practices or imbalanced macroeconomic policies could still be at play. This is where the Treasury’s focus should be.

From that standpoint, Treasury staff work on the oft-maligned report should be praised. The Treasury has consistently produced an informative high-quality analytic document. Foreign governments, the International Monetary Fund, and many analysts focus on its contents. It helps shape global thinking. Even if not finding ‘manipulation’, the report is hard-hitting. Germany complained bitterly about the autumn 2013 report. Korea has long levied loud complaints.

Last week, Mnuchin stated that the foreign exchange report ‘is not a political document’. Though a very welcome statement, a bit of politics is inevitable in every nook and cranny of Washington. In response, the Treasury has intensified slightly the rhetorical passages, but steered clear of ‘manipulation’ designations and delivered a generally informative document. This is one of those occasions when an unsensational report is highly welcome.

*There are two statutes governing the Treasury’s foreign exchange report. A 1988 Act allows for a finding of ‘manipulation’; a 2015 statute provides for ‘enhanced analysis’. While ‘manipulation’ isn’t defined, the 1988 Act follows IMF Article IV, noting that the report should ‘consider whether countries manipulate the rate of exchange between their currency and the United States dollar for purposes of preventing effective balance of payments adjustments or gaining unfair competitive advantage in international trade.’

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