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Opinion: Trump’s Charges of Currency Manipulation Hard to Prove

By Richard N. Cooper

U.S. President-elect Donald Trump promised during his campaign that he would charge China with currency manipulation on his first day of office, which is Jan. 20, with a threat to raise U.S. tariffs on goods from China by 25 or even 45 percent. What was this all about?

The Articles of Agreement of the International Monetary Fund, as amended in 1978, state that “each member undertakes to collaborate … to assure orderly exchange arrangements and promote a stable system of exchange rates. In particular, each member shall … avoid manipulating exchange rates … in order to prevent balance of payments adjustment or to gain an unfair competitive advantage over other members.” (Article IV(iii).)

China joined the IMF in 1980, a prerequisite for being a member of the World Bank, which assisted China greatly during the 1980s with both loans and technical advice, and in so doing China accepted this obligation. At that time, China engaged in very little foreign trade, all by state trading companies. The official exchange rate was 1.5 yuan per U.S. dollar, widely considered to be overvalued but largely irrelevant to the mainly barter trade that took place.

In the early 1980s, China created four special economic zones, later greatly extended, inside China but outside its economic system, whereby joint ventures with foreign firms could use Chinese workers to process duty-free import components for re-export. To encourage exports, firms were exempt from some taxes and could exchange export earnings for Chinese currency at a rate considerably more attractive than the official exchange rate.

For some years China maintained a system of “multiple exchange rates,” or different rates for different transactions. As exports increased and foreign exchange became more plentiful, partly as a result of foreign loans and investments as well as exports, the foreign exchange rate was unified into a single rate in 1994, along with a number of other important policy reforms that year. The rate was set near the prevailing export rates, at 8.28 yuan per dollar in 1995. A year later, 16 years after joining the IMF, China formally accepted Article VIII of the IMF Articles, which required China to provide foreign currency without restriction for all current account transactions — goods, services, earnings on investments — but not for foreign investments themselves.

The official exchange rate against the U.S. dollar remained unchanged for 10 years, until July 2005, but varied against other major currencies, which were floating against the dollar. During this period, the Chinese surplus on current account — trade in goods and services plus net earnings on foreign investment — grew steadily, despite rising imports of oil and a significant increase in world oil prices. The world economy was booming; import barriers were being reduced as a result of the Uruguay Round of multilateral trade negotiations; new markets for Chinese goods opened up; and China’s productivity in manufacturing rose significantly, reducing costs.

The current account deficit of the United States reached an unprecedented 6% of gross domestic product (GDP) in 2006, much of it with China. China’s current account surplus reached an extraordinary 10% of GDP in 2007, much of it with respect to the United States. This was the period in which the charge of “currency manipulation” was leveled against China.

What exactly does it mean? The IMF has never formally defined it. “Manipulate” is defined as “to adapt or change to suit one’s purpose or advantage.” The yuan-to-dollar exchange rate was unchanged for a decade. But it was held there only by People’s Bank of China (PBOC) intervention in the foreign exchange market to prevent the yuan from appreciating against the dollar. China was annually adding to its foreign exchange reserves by buying foreign exchange, which reached a peak of $4 trillion, much although not all of it held in dollars, by the end of 2014. During this period, China maintained tight, although gradually relaxed, controls on outflows of capital by Chinese residents. Arguably, in the absence of such controls, the reserve buildup would have been much less, even negligible.

From 2005 to 2015, with a break during 2008-10, the yuan was allowed to appreciate against the dollar cumulatively about 34%, reaching 6.2 yuan per dollar. In 2015-16 it depreciated, reaching 6.9 by the end of 2016, and would have depreciated even more if the PBOC had not spent over a $500 billion in reserves to buoy the yuan. But the USD appreciated against most other currencies during that period, so the yuan appreciated against other major currencies. China’s current account surplus dropped below 3% of GDP.

Back in 1988, the U.S. Congress passed a trade act that, among other things, called on the U.S. Treasury to identify “currency manipulation.” The target at that time was Japan, not China. The Treasury did not formally name any country under this provision, although it was often encouraged to do so.

Intent is hard to identify. A new law in 2015 revisited the issue and laid down some objective criteria, and called for “enhanced engagement” when met. But formal penalties are weak. In any case, if a country had been named as a manipulator, the law requires “consultations” — a formal diplomatic term — on the issue in an attempt to remedy it. The U.S. Treasury argued, correctly, that it had many formal discussions with Chinese government officials on the issue, and that the Chinese government had responded, although more slowly than the U.S. government would have wished. In any event, at the moment by general consensus the issue is not now alive, at least for China. The yuan is judged to be “fairly valued” against the dollar, although this is admittedly hardly an exact science. And as noted above, the Chinese in recent months have been intervening to prevent a depreciation of the yuan, not an appreciation.

So Trump is out of date. That would not prevent him legally from imposing special import duties on goods coming from China. But China has rights by virtue of its membership in the World Trade Organization: No member may discriminate against goods from China unless they are being subsidized or dumped, each subject to its own set of rules. If Trump imposed such duties, China could complain to the WTO and win the argument — after a year or two. Much damage could be done in the meantime, both to Chinese exports and to the world trading system.

Richard N. Cooper is the Maurits C. Boas professor of international economics at Harvard University.


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