As President Trump and President Xi prepare to meet in the near future, the current environment makes it unrealistic to expect any breakthroughs in bilateral relations.
The sheer complexity of US-China relations, widely differing viewpoints, and the unsettled policy approach by the new U.S. administration make the willingness to meet and talk already an advance.
Trump’s pick for U.S. trade representative, Robert Lighthizer, continued the line that China is one of America’s top trade problems and that it was not clear if Beijing is still manipulating its currency. However, among thorny bilateral issues, the claim that China manipulates its currency for an unfair trade advantage is one of the easier ones to dispel.
At present, most analysts agree that China does not fully meet criteria of manipulating its currency to gain competitive benefits. China has actually used its sizeable foreign reserves to prop up its currency, the Renminbi (RMB) or Yuan, in recent years. As a result, the Renminbi has appreciated more than other currencies in Asia in terms of real effective exchange rates. Moreover, China’s current account surplus, often a proxy measure for currency manipulation, is much lower than during the late 2000s and, at about two percent of GDP, well within reasonable limits. In fact, large capital outflows driven mainly by domestic Chinese interests have triggered a falling RMB, a major headache for Beijing. If the Chinese government manipulates its currency, it is in the opposite direction of what detractors assert.
Nonetheless, in February, some voices within the Trump administration proposed a new approach to naming currency manipulators. Under this plan, the U.S. commerce secretary would gain the right to designate the practice of currency manipulation as an unfair subsidy when employed by any country. This would put U.S. companies in the position of launching anti-subsidy actions with the U.S. Commerce Department. It is therefore still possible that the Trump administration would adopt a tougher stance, accusing Beijing of manipulating the RMB.
In light of this, some voices, such as Sydney University’s Salvatore Babones, have called for a new Plaza Accord modeled on the agreement in the mid-1980s that lowered the value of the U.S. Dollar. In this view, the United States could buy large amounts of Chinese treasury bonds. This potentially elegant solution would increase the value of the Renminbi, arrest in part the problem of capital flight from China, and put the U.S. Treasury in the position of owning a chunk of Chinese government debt with higher returns than U.S. government debt. The financial and political problems facing this solution, however, are enormous. First and foremost is that the U.S. government is unlikely to come up with sufficient funds to make such a deal work. And the Federal Reserve would be resistant to creating these funds when it is raising interest rates and trying to unwind its large portfolio.
A more level-headed proposal would be to recognize the very complex nature of the international currency system and devise a set of accepted rules to govern it. The longstanding proclamations by the G-20 that bans currency manipulation to gain economic advantage actually rings quite hollow when examining the way currency values have been influenced by governments and central banks in recent years.
Put simply, every central bank has to some extent become a currency manipulator in the post-financial crisis order. Quantitative easing, the introduction of zero interest rate policies, and other novel tools of monetary management all have had fundamental effects on currency values. While central banks vehemently state that depressing a currency’s value is not the purpose of these policies, they nonetheless have this effect. The decline of the Euro vis-à-vis the U.S. dollar after the European Central Bank indicated quantitative easing stands testament to this fact.
Chinese management of the Renminbi, however, has been even more hands-on than the policies of most major central banks. The People’s Bank of China (PBOC) has refined an illiberal statist approach by actively managing its currency and the domestic money supply. Rather than opting for the neo-liberal standard of opening the capital account and instituting a free-floating currency, the PBOC has used a more calibrated approach to the Impossible Trinity, which specifies that any economy can only obtain two of three desirables: exchange rate stability, free cross-border capital flows, and domestic monetary autonomy.
Their strategy seeks to combine a gradual but limited, and always reversible, opening of the capital account with market-oriented reforms to the exchange rate mechanism. Beijing thus insists that the Impossible Trinity be recalibrated on its own terms, managing capital flows and using its sizeable reserves to diminish volatility in the RMB’s value. This, in turn, can assure both domestic and international investors with a modicum of currency stability. In fact, the PBOC has started to actively influence offshore liquidity in the RMB to deter speculative forces, forging a novel path of currency management.
These efforts have to be seen in the context of an increasingly unstable global monetary order that is undergoing fundamental change. China is strategically adopting certain financial liberalization measures, while simultaneously seeking to carve out new arrangements supporting RMB internationalization. The label of “currency manipulator” thus misunderstands the present Chinese strategy that seeks to manage capital flows and currency values to create a lower risk profile for the RMB. While the RMB is emerging as a more state-managed currency compared to other major currencies, this by no means constitutes a strategy of “manipulating” its value to gain trade advantages.
Philosophically, the Chinese reject the laissez-faire stipulations of pure free floats for major currencies. In practice, Chinese strategy thus recognizes that the contemporary international monetary system is not a purely liberal system. Various forms of currency management are evident among all actors. Major emerging market economies tend to favor blunter state-guided instruments, including the hoarding of large foreign exchange reserves to manage currency levels as well as capital controls. But even developed economies, by employing quantitative easing and other novel tools of monetary management, have in subtler ways, affected exchange rates.
The international monetary system is therefore in dire need of a new accord that appreciates the changing realities on the ground. Despite some efforts in the G-20, so far there has been little movement in this direction. At a minimum, the major global actors should agree on tighter rules and standards for monetary and macroeconomic surveillance. Likewise, the proposition that some currencies are inherently “free-floating” should be discarded. The present “hybridity” of the system – the managed elements shaping exchange rates – needs to be recognized, producing a clearer and universally accepted definition of what exactly constitutes a state-engineered depreciation amounting to “currency manipulation.”
