Contrary to President Donald Trump’s tweets, nobody wins a trade war. But there is another type of economic conflict that nobody wins either: a currency war. As nations compete in a race to the bottom, citizens are forced to contend with politicians and central bankers beating their chests and grunting like Neanderthals as they determine who can print money faster than The New York Times can change a headline. The clock is ticking and once it strikes high noon, consumers should be prepared for their purchasing power to be eroded.
No Yuan Wants a Currency War
For the first time since 1994, the US government has officially labeled China a currency manipulator. The move comes only hours after Beijing allowed the yuan to crash 1.5% and fall below the crucial seven threshold against the dollar.
The Treasury Department justified the decision by citing a statement from the People’s Bank of China (PBOC) that US officials say is clear evidence that the government has control over the yuan exchange rate. Ostensibly, the Treasury believes that the PBOC’s comments about taking “necessary and targeted measures against the positive feedback behavior” in the forex market is proof of currency manipulation.
“This is an open acknowledgement by the PBOC that it has extensive experience manipulating its currency and remains prepared to do so on an ongoing basis,” the Treasury said in a statement.
Soon after the yuan stabilized, Chinese officials warned Washington that increasing trade and currency strife would “prevent a global economic and trade recovery.” It doubled down on its pledge to not utilize the exchange rate as a tool to negotiate trade deals. The PBOC poetically and ominously urged the US “to rein in its horse before the precipice, and be aware of its errors, and turn back from the wrong path.”
The Treasury can label a country a currency manipulator if a nation spends 2% of its gross domestic product on currency manipulation over a 12-month period. The US government refused to declare China a currency manipulator in May, relying on more stringent criteria – a large trade surplus, a current account surplus, and one-way intervention. But it did promise to monitor China for potential “misalignment and undervaluation” of the yuan against the greenback.
Many observers contend that Beijing has not been purposely debasing the yuan, adding that China had been trying to strengthen the yuan prior to President Trump escalating the trade war. For instance, between July 2017 and April 2018, the yuan had made gains against the buck. Plus, despite exports benefiting from a weaker currency, the country would experience tremendous capital outflows as it did the last time the seven-one ratio happened.
That said, the administration will work with the International Monetary Fund (IMF) to combat unfair competition from the world’s second-largest economy. Moreover, there will now be several months of negotiations and China will be required to pay $20 million in penalties per year.
Despite the harsh rhetoric and policies, Chief White House Economic Adviser Larry Kudlow recently confirmed that President Trump wants to continue negotiating and is trying to host a Chinese delegation in September. Who wouldn’t love to be a fly on the wall should that meeting happen?
The Hall Monitor is Tardy
For years, the United States has urged a myriad of countries to watch their step on any fiscal or monetary policy that might impact the currency exchange rate. Washington has served as the chief international watchdog on this file. But shouldn’t the watchdog be pristine and consistent in its message, too?
Barring the 2015 law the Treasury cited, there are generally two ways to manipulate a currency. The first is to acquire foreign currencies in the forex market to boost their purchasing power. The second is to be a dove: cut interest rates, slash domestic purchasing power, and elevate inflation.
By using these criteria, you could accuse the Federal Reserve and the European Central Bank (ECB) of being the largest currency manipulators in the world.
While they do not have a mandate to directly influence exchange rates, these powerful entities maintain the power to implement measures that can send the dollar or euro higher or lower against a basket of currencies. For instance, if the central bank is engaged in a fierce monetary expansion program, then the greenback would trade lower compared to rivals.
During the early days of QE, the US Dollar Index cratered to as low as 75.00. It has since recovered as the Eccles Building lowered its $4.5 trillion balance sheet by $700 billion and moderated money supply growth to multi-year lows.
Today, the euro continues to weaken against many competitors.
The Fed has directly intervened in forex markets before. In 2000, the administration of then-President Bill Clinton approved the Fed to assist in propping up the euro, which weakened and slipped below the EUR/USD parity. Incidentally, former Treasury Secretary Larry Summers was asked about the difference between Chinese manipulation and US intervention and he dismissed it by noting that “we were asked by the Europeans to respond to weakness in the euro.”
So, those decrying of China possibly manipulating the yuan should cut out the holier than thou malarkey.
In theory, it would make sense for China to devalue the yuan because it would help boost exports, which have fluctuated over the last five years. At the same time, the Chinese economy has witnessed a long-term trend of importing more, something that does require a strengthened currency. Put simply, Beijing is trying to do a balancing act. The experts can argue about the PBOC’s policies, but the conversation should also consist of the often maligned whataboutism: What about the Fed and the ECB? They are not innocent bodies.
Perhaps this whole debate is cause for scrapping the fiat system and adopting a free market currency apparatus. Or, at the very least, return to a gold standard. Is Trump playing a game of 4D chess? He has touted the benefits of gold before, so there a 1% chance this is a ploy to make money great again.
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