Trump's new tactic on China's currency cheating
By Kim Hyeong-woo
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During his presidential campaign, Donald Trump often claimed that China was deliberately keeping its currency low to boost its exports to the United States, and he promised he would label China a currency manipulator beginning on day one of his presidency.
However, President Trump recently backed away from this promise. He said “they’re not currency manipulators” in a recent interview with the Wall Street Journal, even though he also said that the U.S. dollar was getting too strong, which would eventually hurt the U.S. economy.
Some expressed discontent with Trump’s reversal on China’s currency. Senator Charles E. Schumer attacked him, saying that the failure to label China a currency manipulator was symptomatic of a lack of real, tough action on trade against China. Others opposed this trade hawk’s view, pointing out that such a sign of a shift in trade policy would be beneficial to the global economy.
What triggered his reversal on this issue? Many people argued that Trump had to offer a gift to China, seeking its cooperation to resolve the imminent threat to U.S. national security that North Korea poses. Putting it differently, he had to sacrifice his stance on economic issues to coax China into increasing pressure on North Korea to abandon its nuclear weapons program.
I concur with this explanation to some degree. Trump argued in an interview that he didn’t soften his stance on China, implying that this is just a temporary holdup in the middle of negotiations with China on the North Korea problem. Does that mean he would start a trade war with North Korea once the problem is solved? I am skeptical.
I don’t believe the U.S. would be able to “solve” the problem any time soon. But let’s put this aside and focus on something measurable with specific socio-economic facts.
It is perfectly understandable why the U.S. is not happy about the trade imbalance with China. It’s simply too much. In 2016, China’s trade surplus in goods with the U.S. was $347 billion, which corresponds to 46.3 percent of the total U.S. trade deficit. Japan was the second-largest surplus country, but its was a mere 9.2 percent. Korea was eighth and added 3.7 percent to it.
However, there is no compelling recent evidence that Beijing has been manipulating the yuan exchange rate against the U.S. dollar. From around the beginning of the financial crisis in 2006, China indeed has implemented policies that suppressed its currency’s value against the dollar. It accumulated about $4 trillion of foreign exchange reserves mostly in dollars by 2014, because it had to keep buying dollars to make dollars more expensive.
The situation has changed since then. As China’s economic growth continued to slow, Beijing had to reverse its foreign exchange policy. China has intervened in the foreign exchange market to prop up the yuan to stymie capital outflows, because foreign investors were pulling out of the country expecting further depreciation of the yuan. To prevent the yuan from depreciating rapidly, China had to sell an enormous amount of foreign exchange reserves to buy its currency. Consequently, China’s foreign reserves decreased substantially to $3 trillion in 2016. That is, its current foreign exchange policies are exactly the opposite of Trump’s claim during his campaign.
The U.S. Treasury Department also officially confirmed that it will not name China a currency manipulator in its semi-annual report to Congress in April. Based on the Trade Facilitation and Trade Enforcement Act of 2015, the Treasury is required to identify manipulators based on the three criteria: Significant bilateral trade surplus (at least $20 billion); material current account surplus (at least 3 percent of GDP), and persistent, one-sided intervention (at least 2 percent of GDP). No country met all three to be named a manipulator. China met the first one, while Japan and Korea met the first two.
Therefore, it is highly unlikely the U.S. will label China a currency manipulator soon. However, Senator Schumer said, “While they’re not manipulating … at the moment because it doesn’t suit their economic needs … as soon as the tide turns they will.” I do not agree with this view. Policies that keep China’s currency artificially low are inflationary by nature, because the central bank should use domestic currency to buy foreign currency. Therefore, inflation is likely to occur and make domestic goods more expensive, causing the country’s international competitiveness to fall. Also, high and volatile inflation creates economic uncertainty that has a substantial negative effect on growth. This is what happened in China.
Therefore, I think Trump’s reversal is probably permanent on this manipulator issue. Simply put, China is not currently keeping its currency low (and probably won’t do so), and the U.S. needs China’s cooperation to solve peacefully the North Korea problem.
However, Trump has been quite unpredictable. So, he may just begin a trade war without this currency issue once the North Korea problem is settled. For example, one of his recently signed executive orders focuses on tougher enforcement of anti-dumping laws, with severe penalties and countervailing duties. With this, he might be able to win in some industries, returning more manufacturing jobs to the U.S. However, such rewards might come at substantial cost if retaliation begins from China, creating a new “rust belt” in other industries.
Trump's approval rating in the first quarter of his presidency is the worst in recent history. His leadership was questioned after the failure of the American Health Care Act, followed by FBI Director James Comey’s confirmation of the Trump-Russia investigation. His approval rating started to climb when he recently took aggressive military action against Syria, Afghanistan and North Korea. Creating military tensions may be easier for raising approval ratings than solving trade issues. Which direction will he follow?
Dr. Kim Hyeongwoo is an economics professor at Auburn University. He received his Ph.D. from Ohio State University and his B.A. and M.A. from Seoul National University. He has published over 25 SSCI journal articles since 2009 in the areas of macroeconomics, financial economics and economic forecasting. He can be reached at gmmkim@gmail.com.