What is Currency Manipulation? Why is Trump Saying China Does It? Why Does This Matter?

The United States and China have been at odds over trade for quite some time now, but things usually have stayed polite. Tariffs were issued, threats were leveled, but everybody still made a big point to project calm (well, relative to this administration, anyway). President Trump even took pains to talk about how he and President Xi Jinping were totally good friends!

Well, that’s over.

After U.S. Trade Representative Robert Lighthizer and Treasury Secretary Steven Mnuchin returned from recent China trade talks empty-handed, Trump pushed things up a level, saying he would place tariffs on all Chinese imports. 

Then after China responded by allowing its currency to drop in value, the Treasury Department said it is naming China a currency manipulator.

If you believe some of the pundits out there, this is really bad — nay, out of control! And it’s pretty serious — the United States hardly ever names a country a currency manipulator. The last time was… um, China, in the early 1990s.

But you might be wondering… what is currency manipulation? What does it mean?

Let’s break it down.

What is currency manipulation and why does it happen?

Essentially, it is when a country sells its own currency and buys foreign currency — usually U.S. dollars — to weaken its currency and gain a competitive advantage. There are several reasons a country might manipulate its currency, but most often it is a way to subsidize its own exports and raise the price of imports.

There are a number of criteria that the U.S. Treasury Department uses to officially determine whether a country is a currency manipulator, including its current-account surplus, its bilateral goods trade with the United States, the trade surplus with the United States and interventions in foreign-exchange markets.

That sounds wonky. What does this mean in the real life?

When a government lowers the value of its currency, it skews the free market system that countries have agreed to abide by when engaging in global trade. The costs of its exports will be lower compared to imports from other countries, but not because of quality, supply-and-demand or other typical market forces.

Here’s a fictional and simplified example, using Star Wars references!

Say the Ewoks of the forest moon of Endor want to sell their huts across the galaxy. The Ewoks make the best huts around and keep their own costs low, so they make a very competitive product. But Tatooine manipulates its currency, which means that the Made in Endor huts end up being priced high while the huts of Tatooine are priced artificially low. That makes it harder for the Ewoks to sell their huts, both on Tatooine and throughout the galaxy — and even on Endor!

Hey nerd, I said REAL LIFE. I don’t want to go see a Star War.

O.K., here’s another example. Back in the 1980s, Japanese companies enjoyed an unfair advantage in the American market because of a weakened yen. The Reagan administration — not exactly a bunch of protectionist types — compelled Japan via the Plaza Accord to raise the value of the yen, which helped level the playing field for American companies and workers.

Today, Japan continues to be accused of manipulating its currency in order to give its automakers an unfair advantage, both in its own market and around the world. The Ford Focus, for example, was the world’s best-selling compact car in 2013, with 1.1 million sold. Only 800 were sold in Japan. The Economic Policy Institute estimated that nearly 900,000 jobs were lost in 2013 alone because of the U.S. trade deficit with Japan, which is fueled by Japanese currency manipulation.

This remains a sticking point in U.S.-Japan trade relations.

Um, hello! I thought this was supposed to be about China. Does China’s government manipulate its currency?

I mean there’s not even a question. Even this guy says so.

Remember, China is a communist country — its economy is state-run. Of course it is going to manipulate its currency.

But wait a minute. I saw a tweet about how the Chinese actually weren’t manipulating their currency right now though?

Something like this?

Yeah, this is where things get weird.

In recent years, the Treasury Department has determined that China didn’t meet all the criteria to be named a currency manipulator (although we’re among the critics who didn’t agree with that assessment). But after Trump announced the latest round of tariffs last week, China got real mad and stuck it to the U.S. by allowing the yuan to fall in value.

There’s a lot of debate about whether this is technically currency manipulation or whether it was China ironically not manipulating its currency for once.

The Treasury Department, for its part, isn’t buying it. Explaining the designation, Treasury argues that in recent days “China has taken concrete steps to devalue its currency, while maintaining substantial foreign exchange reserves despite active use of such tools in the past. The context of these actions and the implausibility of China’s market stability rationale confirm that the purpose of China’s currency devaluation is to gain an unfair competitive advantage in international trade.”

Treasury further argues that “Chinese authorities have acknowledged that they have ample control over the RMB exchange rate” and that they have “extensive experience manipulating its currency and remains prepared to do so on an ongoing basis.”

But if China has always manipulated its currency, why is this just happening now?

THAT’S A GREAT QUESTION.

We’ve long called for the Treasury Department to name China a currency manipulator. Here’s AAM President Scott Paul talking about it back in 2009. He’s so young!

And you will recall Trump pledged to name China a currency manipulator on his first day in office, which he didn’t do. Former President Barack Obama also promised to get tough on China, but never did, despite plenty of evidence and widespread agreement that China was manipulating its currency.

Diplomacy always came into play. Everyone knew the designation would anger the Chinese and it wasn’t worth it — there were other priorities deemed more important.

But Trump was mad at China on Monday. Real mad. Tweeting about it mad. China’s decision to let the yuan fall — along with its announcement that it would stop buying U.S. agricultural products — hit the markets hard. Trump knew he had this card in this back pocket, and he decided to play it.

What happens now?

F— if I know.

It’s possible that the U.S. will use it as justification to issue more tariffs or exclude China from U.S. government procurement contracts. It also could ask the International Monetary Fund to monitor China’s monetary policies more closely. Given the IMF’s track record there, however, we aren’t holding our breath.

The most immediate result is that China is angry and Trump is still angry and everybody is angry — which means the trade war between the two economic powers isn’t about to end anytime soon.

Posted In: Allied Approaches