Trump keeps getting things wrong about trade and its relationship to the currency market. He simply does not recognize that the two fundamental drivers of that depreciation are his own trade and fiscal policies.
By James DiGeorgia
President Donald Trump has been accusing China falsely of keeping the renminbi weak artificially since his 2016 presidential campaign. The President’s own economic policies are however driving the value of the dollar up. This outcome could have been predicted by anyone with a basic economics understanding.
The US Department of the Treasury will submit its biannual report to Congress soon, listing which countries, if any, manipulate their currencies to gain unfair trade advantages. Trump is reportedly attempting to influence the Treasury’s discussions and has accused China of doing this throughout the 2016 elections.
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In the last submission in April, the report, like others written during the previous two administrations, did not find that China is guilty of manipulation. The Treasury Department last found China, or anyone else for that matter, a manipulator in 1994.
The reason is simple: the three criteria that Congress has set for defining currency manipulation have not been met by China. It does not persistently intervene in foreign-exchange markets to push down its currency, nor does it have an overall current-account surplus more than or equal to 3% of GDP. China’s surplus was in fact 1.3% in 2017.
China does, however, meet the third criterion as it has a bilateral trade surplus with the US exceeding $20 billion. Congress was however in error when they set the bilateral balance as a criterion. The bilateral deficit can easily be explained by the massive US trade deficit worldwide. As China is responsible for 15% of the world economy, the country’s proportional share of America’s $600 billion deficit would be $90 billion – well above the $20 billion limit set by Congress. Although the bilateral deficit is much more than even that level, this is due to China’s US exports containing many imported inputs.
As of April, China met only one of the three criteria set by Congress, and it, therefore, does not qualify as a currency manipulator. A number of other countries met two criteria, including India, Japan, South Korea, Switzerland and Germany. Since April, the renminbi has depreciated against the dollar by 6%, but this is due to the dollar itself appreciating by 7% on a broad front against its trading partners’ currencies.
Exchange rates do not always follow models designed by economists. In this case, however, Trump’s own economic policies can explain the dollar’s appreciation.
Trump is pursuing huge pro-cyclical fiscal expansion, and this has produced unprecedented peacetime budget deficits without the presence of a recession. The expansion includes tax reductions in December, a huge increase in government spending, and recent proposals for more tax reduction.
Macroeconomic theory predicts that these policies should lead to increased interest rates, attract foreign capital, and strengthen the dollar. This happened when America had a similar fiscal-monetary mix in 1981 to 1984 under President Reagan.
Trump has also launched a trade war by levying import tariffs on the US’ major trade partners, the most recent of which is tariffs on another $200 billion of Chinese exports. Although he believes this will improve the country’s trade balance, he does not understand that if foreign exporters are prevented access to US markets, they won’t have dollars to purchase US goods.
A decrease in US imports as a result of tariffs can be offset in several ways. Other countries could easily retaliate against America by imposing their own tariffs on, for example, US agricultural exports. Irrespective of whether they do or don’t, actions that make it more difficult for foreign exporters to earn dollars will create scarcity, which will automatically boost the currency’s value in a floating exchange rate environment. The escalation of the trade wars in 2018 has indeed had this effect on the USD as predicted by economic theory.
China did, however, depress the value of the renminbi a decade or so ago. Together with rising current-account and trade surpluses, the PBOC (People’s Bank of China) instituted a policy to dampen appreciation by intervening in foreign-exchange markets, resulting in them amassing huge reserves of foreign exchange. China then, however, changed its currency policy and the renminbi appreciated by 37% from 2004 to 2014, thereby eliminating its undervaluation.
Capital started flowing out of China in 2014, and the currency depreciated. This was mainly due to relatively strong growth in America, the Chinese economy slowing down, and a corresponding shift in the monetary policies of the respective countries. Just as the Chinese bank intervened to reduce the renminbi’s appreciation between 2004 and 2014, it started intervening to reduce the currency’s depreciation after 2014.
This type of intervention is known as “leaning against the wind.” The PBOC tried to stop the renminbi’s slide after 2014 by spending $1 trillion. If Chinese authorities had consented to US demands and allowed the market to determine the exchange rate, the renminbi would have depreciated even further, and American exporters would have found it more difficult to compete.
US politicians eventually understood this basic fact, and Trump was the last one to grasp it. Trump still labeled China as “world champions” of currency manipulation on April 2, 2017, only to tell The Wall Street Journal a week later that they don’t manipulate their currency. After letting the subject rest for a year, he recently repeated his original accusations.
Coincidently, China suspended its efforts to prop up the currency the year during which Trump did not accuse them of pushing down the currency. Its foreign-exchange reserves did not decline further in 2017. China has now resumed efforts to defend the renminbi, at a time when Trump has renewed his accusations. The PBOC recently indicated that it will use a counter-cyclical factor when it adjusts the renminbi against the dollar daily to limit the currency’s depreciation.
Trump keeps getting things wrong not only because of his perverse personality. He keeps making the charge while the renminbi depreciates and the PBOC intervenes to support it. Trump simply does not recognize that the two fundamental drivers of that depreciation are his own trade and fiscal policies.