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This article first appeared in The Edge Financial Daily, on February 7, 2017.

 

THE Trump administration has come out firing against two major US allies recently, accusing them of currency manipulation. Last week, at a meeting with heads of pharmaceutical companies, US President Donald Trump mentioned China and Japan: “Every other country lives on devaluation ... you look at what China’s doing, you look at what Japan has done over the years. They ... play the money market, they play the devaluation market and we sit there like a bunch of dummies.”

Meanwhile, Trump economic adviser Peter Navarro told the Financial Times that Germany’s trade surplus is a sign that the euro is “grossly undervalued”.

Are Trump and his advisers right? In some ways, yes; in some ways, no.

There is no doubt that China manipulates its currency. The country ties the value of its currency, the yuan, to the value of a weighted average of other currencies — it can only trade within a narrow band set by the government. If market forces try to push the yuan out of that range, the government trades in the foreign-exchange markets until the currency is back within its bounds.

During the 2000s, when the yuan was firmly pegged to the US dollar, almost everyone agreed that China’s currency was substantially undervalued. This helped China to maintain a large trade deficit with the US — China shipped goods to the US, and the US wrote China IOUs in return. That trade deficit contributed to the massive economic dislocation that we now call the China Shock. US workers were hurt, even as the US repeatedly refused to label China a currency manipulator. Trump is probably right that we were dummies.

But in recent years, the situation has changed. The yuan is no longer undervalued. As China’s economy slows and its asset markets look shaky, capital is flowing out of the country. That pushes the value of the yuan down. China still manipulates its currency, but it is now probably propping it up rather than holding it down. If China ends its manipulation, the yuan will probably get even cheaper, making its goods even cheaper in the US.

How about Japan? Trump is also correct in saying that Japan has manipulated its currency over the years — though the amount of manipulation is far less than what China does. In 2003 and 2004, the Bank of Japan bought hundreds of billions of dollars, pushing down the yen against the US currency in an attempt to give its exporters a boost.

The attempt failed. The yen weakened against the dollar in 2004, but not much, and it did not last (see Chart 1 — Ups and Downs but Nothing Unusual).

And Japan’s trade surplus did not change much at all (see Chart 2 — Not Much Change After All).

The country largely abandoned its attempts to hold down the yen, even when it started running a trade deficit in the 2010s. A few half-hearted interventions since the early 2000s have had little effect. Currency manipulation, as economic research shows, just is not that reliable a tool.

Some allege that Japan’s huge programme of quantitative easing (QE) via asset purchases constitutes a form of currency manipulation. But this is not really right. Theoretically, lower interest rates can cause capital to flow out of a country, weakening the currency and raising exports. But this effect is weak. Japan’s interest rates are already at zero and cannot go any lower, and QE has failed to create any lasting inflation. Money is not pouring out of Japan, and the country is barely running a trade surplus.

So while Trump is right about Japan’s past, it is also not an important issue right now.

As for Germany, Navarro’s argument is on pretty weak footing. Germany is one of 19 countries that use the euro, so to say Germany is manipulating its currency is like saying that Texas is manipulating the dollar. What is true is that the way the eurozone is set up tends to make Germany run a trade surplus with other European nations. Essentially, other euro countries would need to have easier monetary policy than Germany in order to balance out the flow of trade — but they cannot, because there is only one monetary policy for the whole eurozone.

In other words, Germany’s surpluses are a problem, but they are a problem within Europe, and they are due to the setup of the eurozone rather than to the manipulation practiced by China.

So while I sympathise with Trump’s frustration about China’s past policies, and I share Navarro’s concerns about Germany’s trade surpluses, I am pretty sure that branding these countries as currency manipulators would not help the problem. It would not fix the euro’s problems, and it would only make China’s currency even cheaper. And Japan is not manipulating its currency anymore. The US should try to improve its trade balance, but fighting against currency manipulation will not be a very effective strategy at this point in time. — Bloomberg

 

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