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China and manipulation machinations: the FX of devalued gestures

The US has labelled China a currency manipulator, but both that and the sudden but small preceding renminbi devaluation were more symbolic than anything else.

China is now officially a currency manipulator, at least in the opinion of the US Treasury Department. It adds a chapter to the US-China trade war and follows last week's new round of tariffs

What does this mean?

The US Treasury reports on currency manipulation twice a year, in April and October. There are three criteria for branding a country a currency manipulator:

1. If it has a bilateral goods surplus with the US of more than $20 billion (China’s surplus reached a record $419 billion in 2018).

2. If it has a current account surplus of more than 2% of GDP (the threshold used to be 3%, but was tightened this year).

3. If it has engaged in persistent and one-sided currency intervention, in at least six out of the past 12 months, worth more than 2% of GDP (this used to be in eight out of the past 12 months, but was also tightened this year).

In the most recent report, the release of which was delayed until May, no country met all three criteria and so none were branded a currency manipulator. However, several countries are on the monitoring list, including China, Japan, South Korea, and Germany.

Now, you will remember that the next manipulation report – officially titled Macroeconomic and Foreign Exchange Policies of Major Trading Partners of the United States – is not due until October. This week’s declaration therefore strikes us as clearly political in nature.

Yuan way or another

The broader context is also relevant: China may have been intervening but it was doing so to prevent depreciation, not to weaken the currency.

Publicly, the Chinese authorities claimed they were maintaining a steady exchange rate, but in doing so actually had to step in to prop up the renminbi by buying it offshore and by increasing the regulatory costs of speculating against the renminbi.

In theory, of course, you would expect free-market forces to depress a currency when its country is hit with tariffs. We can therefore infer from the stability of the renminbi through most of the trade war that China has been defending the exchange rate.

Again, this suggests to us that the US government had politics primarily in mind when it tagged China as a currency manipulator this week.

There is one more element to this. The point of labelling a country a currency manipulator in this formal manner is that it justifies imposing tariffs on that country. As we know, the US is already doing that so this week’s designation is essentially a toothless act of political theatre.

It is perhaps not only the US that is grandstanding, though. A renminbi exchange rate of seven versus the US dollar was a fairly arbitrary level, but there was a market belief that seven was a line in the sand for the People’s Bank of China. By declining to intervene and so letting the renminbi drop, China was also making a political statement.

The fact that China has since kept the exchange rate steady reinforces our belief that this was a shot across the bow, not the start of a major currency devaluation. We don’t expect the rate to weaken beyond 7.2 or 7.3 this year, not least because a sustained weakening would make it harder for the Chinese government to control capital outflows and so it would not be in their interest.

Overall, I think we should view this episode as more symbolic than anything else, although it could be repeated if and when more sanctions are imposed.