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US - China

  Mar 18, 2020

US - China

What is currency manipulation?

Countries can weaken their currency by intervening in currency markets and purchasing U.S. dollars. This makes dollars more expensive and the other country’s currency weaker. It is manipulation as it does not allow normal market forces of demand and supply through international trade and capital flows to prevail. It is currency devaluation most of the time as devaluation has many gains. 

What are the gains?

Once the currency is weaker, goods from that country become cheaper on international markets, potentially providing a substantial boost to exports. For example, rupee becomes weaker against dollar then more Indian goods and services can be purchased for a given US dollar and thus India can sell more abroad. Our exports will go up.

It helps countries to gain “an unfair competitive advantage in international trade.”

In a textbook example of currency manipulation, a country would have a giant overall trade surplus because its artificially low currency would make its exports far exceed its imports.

Why China?

In recent years, China has been the center of concerns. Policy makers from both parties have long worried that China artificially weakened its currency to make its exports cheaper on the world market, boosting its economy and balance of payments.

Why did the U.S. act now?

Beijing controls the exchange rate. The People’s Bank of China has vast holdings of foreign currency that it can use for purchases or sales during interventions.

Over the past decade, China has sometimes controlled the rate tightly by pegging it to dollar or any other set of foreign currencies in such a way that it remained weak.  Pegging it means fixing at a certain level and defending it by forex market intervention. It remained at little less than 7 yuan: got close to 7 but didn’t break through.

That changed in August 2019, as trade relations between the U.S. and China took another step backward. After a round of negotiations in Shanghai, the U.S. failed to secure specific farm purchases, and responded by promising a new round of 10% tariffs on nearly $300 billion in goods. China said it was halting purchases of U.S. agriculture products. China’s yuan dropped to a record offshore low of 7.11 to the dollar.

Was it manipulation or panic?

China’s central bank has said the yuan broke through the threshold because of market forces. Indeed, hitting a country with large tariffs typically has the effect of weakening its currency. But because Beijing can tightly control its currency, it means when such a move happens that they at least passively allowed it, even if they didn’t actively engineer it. The higher tariffs are neutralized by the weaker currency.

How serious is the move?

The move is considered largely symbolic.

The ultimate reason for designating a country a currency manipulator is to justify some sort of retaliation. But the Trump administration has already shown both its ability and willingness to use other authorities to impose sweeping penalties against China for policies the president says treat the U.S. unfairly.

In theory, the U.S. could try to intervene in currency markets on its own to offset China’s weakening exchange rate. But in the U.S, it is the Federal Reserve, the central bank that has to do it and it is an independent entity unlike in China.

What is the global impact?

Financial markets were in turmoil as a result. There is apprehension that the escalating US-China economic tensions will bring down global growth. Indian rupee also fell below Rs.70 to one USD.

Does India manipulate?

India has floated its rupee since 1990's. Market forces largely bring the rate. RBI's intervention is not meant to regulate the rate but to remove disorder from forex market. Therefore, there is no case to say that Indian currency is manipulated.