Romney’s Threat to Declare China a "Currency Manipulator"

October 18, 2012

If elected president, Mitt Romney has promised to reclassify The People’s Republic of China as a currency manipulator immediately after taking office.  It’s unlikely that he could do this before May.  The Treasury Department, a branch the executive department, examines currencies semi-annually in May and November, and those reports provide the venue for deciding if any trading partners are engaged in currency manipulation.  It will be a few days after Mr. Romney is sworn in before the first such study under his stewardship is completed. 

The background for these reports and their potential influence on U.S. commercial policy is stated in the May 2012 Report to Congress on International Economic and Exchange Rate Polices.

The Omnibus Trade and Competitiveness Act of 1988 (the “Act”) requires the Secretary of the Treasury to provide semiannual reports on the international economic and exchange rate policies of the major trading partners of the United States. Under Section 3004 of the Act, the Report must consider “whether countries manipulate the rate of exchange between their currency and the United States dollar for purposes of preventing effective balance of payments adjustment or gaining unfair competitive advantage in international trade.” This Report covers developments in the second half of 2011, and where pertinent and available, data through mid-May 2012. Treasury has concluded that no major trading partner of the United States met the standards identified in Section 3004 of the Act during the period covered in the Report.

In discussing China, the May Report had this to say:

China’s current account surplus has fallen markedly over the past four years, from 9.1 percent of GDP in 2008 to 2.8 percent of GDP in 2011. Some of the reduction reflects weaker demand growth in China’s major trading partners, the large impact of rising commodity prices on China’s trade surplus and unsustainably high rates of domestic investment in China. However, some of the improvement reflects structural adjustments in the Chinese economy, continued wage increases in the manufacturing sector, and the effects of renminbi (RMB) appreciation. China is gradually allowing necessary external adjustments to take place, as indicated by the decline in China’s current account surplus together with real appreciation of the RMB since June 2010 and China’s steps to gradually open its capital account.

Nevertheless, the underlying factors that distort China’s economy and constrain global demand growth remain. China accumulated $373.1 billion in additional foreign exchange reserves in the first three quarters of 2011. Reserve accumulation slowed in the fourth quarter to $11.7 billion, but increased again to $74.8 billion in the first quarter of 2012. At the end of March 2012, China held $3.3 trillion in foreign reserves, equivalent to 45 percent of China’s GDP in 2011.

At the May 2012 U.S.-China Strategic and Economic Dialogue (S&ED), Chinese authorities stated that China will continue to enhance exchange rate flexibility, letting supply and demand play a more basic role, and re-iterated their determination to implement fully their G-20 commitments to move more rapidly to a market-determined exchange rate system and avoid persistent exchange rate misalignments. Recently, China widened the daily RMB trading band, a move that has the potential to increase exchange rate flexibility and adjustment if it is implemented in a way that allows the value of the exchange rate to better reflect market forces. China has also taken steps to liberalize its capital account, including by increasing the ability of portfolio investors to invest in Chinese assets and the ability to externally raise and use renminbi funds for investment in China.

Based on the appreciation of the RMB against the dollar since June 2010, the balance of payments adjustment evidenced in the decline in China’s current account surplus, and China’s commitments in the G-20 and S&ED that it will move more rapidly to a more market-determined exchange rate system, Treasury has concluded that the standards identified in Section 3004 of the Act during the period covered in this Report have not been met with respect to China. Nonetheless, the available evidence suggests the RMB remains significantly undervalued and we believe further appreciation of the RMB against the dollar and other major currencies is warranted. Treasury will continue to closely monitor the pace of RMB appreciation and press for policy changes that yield greater exchange rate flexibility, level the playing field, and support a pronounced and sustained shift to domestic-demand led growth.

In the nearly six months since Treasury Department analysts made those determinations, much has happened to weaken the case for declaring China a currency manipulator.

  • Chinese international reserves fell about $65 billion in the second quarter and rose around $50 billion last quarter.  In other words, the extensive growth of reserves, an indicator of an undervalued currency, slowed to a crawl. 
  • The IMF released a report earlier this month that forecast China’s current account surplus narrowing further to 2.4% of GDP on average this year and next.  This is much smaller in relative size than projected surpluses in Germany averaging 5.0% of GDP, Sweden (7.5% of GDP) and Singapore (21.9% of GDP). 
  • A recent article in the Financial Times by Michael Mackenzie observes that holdings of U.S. Treasuries by Japan ($1.121 trillion) and China ($1.153 trillion) have largely converged as a result of Japan’s on-year rise of $204 billion and China’s drop of $125 billion.  The renminbi, also known as the yuan, had meanwhile risen 2% against the dollar since mid-August and shows a nominal advance since July 20, 2005 of 32.6%.  From this base date, by comparison, the euro has appreciated on net by 7.7% against the dollar, while the yen has soared 42.1%.
  • The IMF’s World Economic Outlook from this month acknowledged a wide disparity in estimates of the yuan’s remaining undervaluation ranging from as much as 23% to as little as a mere 3%.

Romney provocative stand on China is one of five components of his broader strategy to reduce U.S. unemployment.  One sees that grounds for declaring China are really not so clear cut, and the basis for making such a designation is subsiding.  His pledge to change China’s trade status on day one of his presidency also provides a glimpse into his intended use of presidential powers.  The determination of whether a country is a currency manipulator or not should not be made in a rush to judgment by one person, even the president, but rather only after a careful examination by his Treasury team of all pertinent facts, and these studies are to be conducted at six-month intervals scheduled well in advance.  Finally, one has to wonder if the potential costs and benefits of China bashing make this a smart approach.  China’s economy is in a slowdown, and political leadership is in a once-in-a-decade transition.  A strong protectionist fight with the world’s second largest economy without the United States being more sure of its facts risks a big public relations setback at a time when markets and voters are impressionable.

Copyright 2012, Larry Greenberg.  All rights reserved.  No secondary distribution without express permission.

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