he U.S. Treasury talked about whether South Korea was guilty of it in 2018. Japan’s reflation policies, which devalued the yen against the dollar, earned the island nation similar accusations in 2017. And current American President Donald Trump accused China of currency manipulation while on the campaign trail.
Currency manipulation happens when a country pushes against the natural market forces which regulate the trade balance. Under free trade, when countries export more goods than they import, they find themselves in a trade surplus, and their currencies rise in value. After all, a country experiencing a trade surplus is selling more goods than it is buying, increasing the demand for its domestic currency and thus allowing it to rise in value. Conversely, when countries import more than they export, they find themselves in a trade deficit, and their currencies decrease in value. A country experiencing a trade deficit buys more goods than it sells, flooding the international market with its domestic currency and pushing the value of that currency down. Under free trade agreements, the market determines exchange rates between countries, and global trade “theoretically balances out.”
Currency manipulation, however, works against this balance. A country that finds itself in a trade surplus, for example, is supposed to see its currency rise in value, allowing that country to buy more goods from the rest of the world. If that country wants to artificially lower the value of its currency instead, perhaps to prop up its own exports, it could use the extra currency it earned from its trade surplus to buy foreign currencies instead of foreign goods. Doing so keeps the cost of foreign goods high and lets the country continue to reap the benefits of affordable exports by keeping its domestic goods relatively cheap.
In the U.S., the Department of the Treasury defined currency manipulation under three criteria in a 2015 trade regulation. First, the country must have a “significant” trade surplus with the United States. Second, the country must have a “material” trade surplus with the rest of the world. Lastly, the country must persistently intervene in foreign markets to push the foreign currency exchange in a certain direction.
On Monday, August 5, 2019, President Trump’s Treasury Department officially accused China of currency manipulation in the latest climax of the United States’ escalating trade war with Beijing. Hoping to ease the pain of Trump’s next round of tariffs, China’s central bank, The People’s Bank of China, allowed the value of the renminbi to weaken.
China has notoriously manipulated the value of its currency for years, keeping the value of the renminbi artificially low from the early 2000s to 2014 as a way of propping up its exports industry. In 2007, China’s broad trade surplus accounted for 10% of its GDP. The hefty trade surplus accounted for a full third of America’s trade deficit with the rest of the world.
China’s material account surplus is a meager .4% of its GDP—much less than the 2% of GDP required to place it under Treasury Department suspicion for currency manipulation.
China, however, isn’t manipulating its currency now. Economists speculate that the Asian economic giant is likely just refusing to bolster the renminbi’s value as American tariffs take their toll on the Chinese economy. Further, China doesn’t even meet the U.S. Department of the Treasury’s guidelines for currency manipulation. In May 2019, the Treasury failed to accuse any country of currency manipulation in its biannual report detailing the foreign exchange habits of its trading partners. As previously mentioned, in order to be found guilty of currency manipulation under U.S. law, a country has to maintain large trade surpluses and exhibit proof of intervening in the foreign exchange market. American law poses quantitative standards for each of the three criteria.
As Columbia professor Jeffrey Sachs notes, China does have an at least $40 billion trade surplus with the United States, meeting the threshold for the first criterion of currency manipulation. However, when it comes to the other two criteria (boasting a large material account surplus with the rest of the world and exhibiting consistent intervention into foreign exchange markets), Trump’s charge against the Chinese seems much less convincing. China’s material account surplus is a meager .4% of its GDP—much less than the 2% of GDP required to place it under Treasury Department suspicion for currency manipulation. And what’s more, Beijing hasn’t demonstrated the large increase in foreign exchange reserves (which the Treasury Department defines as a 2% or more increase in foreign exchange reserves over a 12-month period) that would evidence formal currency manipulation.
In a twisted version of the classic fable, Trump might be crying wolf long after the beast has let beleaguered sheep be. Whether China is manipulating its currency or not, however, ultimately doesn’t matter. As the trade war escalates, larger economic effects are being felt around the world. Monday’s currency manipulation accusation, for example, led to Wall Street’s worst day this year. And on Wednesday, three countries—India, Thailand, and New Zealand—cut interest rates, anticipating additional global market impact from Trump’s ongoing trade war. It remains to be seen whether this trade warfare will wreak further havoc on an already tense global economy.