Tag Archives: currency manipulation

The Sound Of Another Trump Flip-Flop

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IT IS ALL going rather swimmingly for China with the United States right now. Following the happily smooth summit between President Xi Jinping and US President Donald Trump in Florida last week, the US president has said that China is not manipulating its currency.

During his election campaign last year, Trump had repeatedly accused Beijing of artificially driving down the value of the yuan to increase its export competitiveness, and had said he would label China as a currency manipulator on his first day in office.

His about-turn pre-empts the US Treasury’s forthcoming biannual report to Congress on the foreign-exchange policy of the United States’ principal trading partners: being designated a currency manipulator by the US Treasury legally triggers US Congressional sanctions against the offending country.

In the Obama-era, the Treasury had always found a way to avoid that, but the risk to China once Trump won the election last November was acute.

Trump now accepts that China has not been manipulating its currency for a while. His need to work with Beijing on dealing with North Korea — regardless of his previous comments that the United States would take unilateral action against Pyongyang if China failed to rein in its neighbour as Washington expected — appears to have helped clarify his vision.

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Beijing’s Devaluation Dilemma

 

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THE CLOCK IS ticking down on the inauguration of US President-elect Donald Trump and thus on Beijing’s decision about if and how to devalue the renminbi. China is caught between an exodus of capital and whatever hawkish policies against it that a Trump administration could bring.

The renminbi fell 7% against the US dollar in 2016, in its biggest fall since 1994. Most of the fall occurred in the fourth quarter as the US Federal Reserve started to raise interest rates.

The case for a one-off step devaluation is that it would, assuming it was large enough, staunch the outflows, and end the need to run down the foreign-exchange reserves to defend the currency. The case against is that Chinese companies with dollar-denominated debt could be put in peril, importers would face a squeeze on margins and Trump’s strident accusations of China being a currency manipulator to support its exporters by undervaluing the renminbi would gain more credence.

Also, a Chinese devaluation could set off a round of competitive devaluations by emerging economies that would rock the world economy. There is ‘previous’ in this regard. Beijing’s unexpected devaluation in August 2015 caused global shockwaves.

At the same time, China’s foreign exchange reserves, being used, regardless of Trump’s claims, to prop up the currency through market intervention, are being eroded. While comfortably large at more than $3 trillion, even they cannot be run down indefinitely. The People’s Bank of China has already used $1 trillion of the reserves to defend the currency, taking them in December to their lowest level in six years.

And what probably matters more is investor sentiment. To that end the central bank earlier this month orchestrated liquidity squeeze in the offshore market in Hong Kong, to make it more expensive to bet against the renminbi, a signal intended equally to be read in the onshore market.

As the devaluation debate rages among policymakers, Beijing has been putting administrative measures in place to reduce the outflows. A stop has been put to the dodge of using investment-linked insurance policies in Hong Kong both to move savings overseas and switch into dollars. The level at which banks are now required to report all yuan-denominated cash transactions has been lowered to 50,000 yuan from 200,000 yuan.

The individual annual quota of $50,000 in foreign currency is unchanged, but citizens are being asked for more detailed information about why they need the cash;  tourism, business travel and medical care and education overseas is looked on favourable, but not purchases of overseas property and financial assets.

Similarly, a closer eye is being kept on Chinese firms foreign direct investment, especially M&A involving real estate, hotels and cinemas. Bitcoin exchanges, which account for 95% of global trading in the crypto-currency, are being leant on to stop a backdoor way to cash out of the yuan. There is even speculation about a crackdown on the excessive transfer fees Chinese football clubs are paying to bring in foreign stars.

In this environment, state-owned enterprises are likely to be leant on to repatriate foreign currency earnings held offshore while foreign firms will find it harder to repatriate their profits.

All of this flies in the face of policies to internationalise the currency that have been persued for some time, and whose continuance was implicit in the IMF’s adding of the renminbi to its basket for Special Drawing Rights last October.

The other conventional prop for a currency is higher domestic interest rates. However, with more than 1 trillion yuan of corporate bonds due to mature every month from now until the third quarter of this year, higher rates would impose a massive refinancing burden on companies.

Also, it is far from clear how much strain higher rates would put on the shadow banking system and what the spillover would be to the rest of the financial system, but the sense is that it is a significant risk.

That leaves devaluation — gradually or in a one-step change — as the most likely option.

In a sense, that is inevitable. Dollar strength globally is probably a bigger factor than renminbi weakness. Last month, however, that did not prevent Trump tweeting, “Did China ask us if it was OK to devalue their currency?” Nor is it likely to do so again.

Financial policymaking is difficult at the best of times, never more so than at a time of unpredictability — and with a clock ticking.

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Beijing’s Currency Wars Playbook

Beijing will play its usual defense against the moves in the U.S. Senate to twist China’s arm to appreciate its currency against the dollar: vociferous denunciation of Washington for turning protectionist and initiating “trade wars” while patiently waiting out the start of any serious hostilities, calculating that the threat of them will eventually recede.

The denunciation has duly come with Foreign Ministry spokesman, Ma Zhaoxu, saying the bill now in front of the U.S. Senate proposing punitive measures against any country that is shown to be manipulating its currency — for which read China — “seriously violates rules of the World Trade Organization and obstructs China-U.S. trade ties”. He told U.S. Senators to abandon protectionism and stop politicizing economic issues. He also told them to “stop pressuring China through domestic law-making”. Co-ordinated sentiments have been expressed by the central bank and the commerce ministry.

While perhaps nobody outside the U.S. Congress really believes that a sharp revaluation of the yuan on its own will eradicate America’s trade deficit with China or create the new domestic jobs the U.S. is having such trouble generating, Beijing will know that even if the Democratic majority in the U.S. Senate passes the bill, the legislation will likely founder in the Republican controlled House of Representatives. Even if it does not, it is highly unlikely to survive a presidential veto. That is the past pattern of such proposed legislation. Support for this year’s bill appears to be stronger, helped by its narrower provisions and the background of sluggish U.S. growth and joblessness, but the odds remain long that it will become law.

At the very worst from China’s point of view, and the bill does become law, it will be cheaper politically for Beijing to fight any punitive measures through the WTO than it would to be seen to capitulate to foreign pressure. Meanwhile, it can bide its time, letting the gradual appreciation of the yuan that has been underway since June last year (up 7% against the dollar since then and 10% against the euro) ease the U.S. pressure, which is anyway likely to abate after next year’s U.S. elections. Simultaneously, it buys more time for the economy, particularly the export-manufacturing sector, to adapt.

China’s policymakers are quite happy for the yuan to appreciate. It will help them both fight inflation and restructure the economy. They just want do it to their timetable, not Washington’s–and they have the playbook to do that.

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Inflating The Yuan’s Value, Not Manipulating It

The U.S. Treasury has danced its way, as is its wont, around designating China as a currency manipulator. In its latest half-yearly report to the U.S. Congress, it says that China’s high inflation means that the yuan’s real (inflation-adjusted) exchange rate with the U.S. dollar has risen by an annualized 10% since Beijing started allowing its currency to rise again against the greenback last June. On a nominal basis the yuan rose 3.7% over that time.

Were the Treasury to declare that Beijing was manipulating its currency, it would trigger retaliatory actions by the Congress, where many believe that it does. That, though, would be a ramping up of Sino-American tensions that neither government would want to deal with, especially in the wake of President Hu Jintao’s state visit to Washington last month that put the relationship on a less overtly confrontational footing.

The Treasury did, however, repeat another of its favorite tunes, that the yuan remains “substantial undervalued” agains the dollar, and that more rapid progress is needed in its revaluation.

China’s real effective exchange rate has appreciated only modestly over the past decade. China’s large increases in productivity in export manufacturing, improvements in transportation and logistics, and China’s accession to the WTO all suggest that the [yuan] should have appreciated more significantly on a real effective basis over this period.

To seek to change that, the Treasury strikes a note of encouragement, rather than chiding:

It is in China’s interest to allow the nominal exchange rate to appreciate more rapidly, both against the dollar and against the currencies of its other major trading partners. If it does not, China will face the risk of more rapid inflation, excessively rapid expansion of domestic credit, and upward pressure on property and equity prices, all of which could threaten future economic growth. By trying to limit the pace of appreciation, China’s exchange rate policy is also working against its broad strategy to strengthen domestic demand. And China’s gradualist approach on the exchange rate also adds to the substantial pressure now being experienced by other emerging economies that run more flexible exchange rate systems and that have already seen substantial exchange rate appreciation.

Beijing’s policymakers know that that to be the case. They are just doing a slow foxtrot with the yuan for domestic social and political reasons, and won’t be rushed into picking up the tempo.

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U.S. Treasury Dodges Declaring China A Currency Manipulator

The U.S. Treasury is mandated by law to issue a report every six months on whether any country is manipulating its currency for an unfair trade advantage. Although, or more likely because the exchange rate between China’s yuan and the U.S. dollar, is so political charged now, the Treasury has booted down the road taking a decision on whether to declare China a currency manipulator as charged by so many in the U.S. It says it will wait not just until after the U.S. mid-term Congressional elections on Nov. 2nd, but also the Seoul summit meeting of G-20 leaders on Nov.11 and the Asia Pacific Economic Cooperation forum summit on Nov. 13-14. Those meetings may come to some agreement, though we think that unlikely, so the U.S. Treasury’s delay looks like a Hail Mary pass while its scrambles, to mix a metaphor, to take a policy high-road:

The challenge of building a stronger, more balanced and sustainable global economic recovery is a multilateral challenge, not just the responsibility of China and the United States.  It requires policy reforms in all major economies.

We know that is right, but good luck with that anyway.

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U.S. Vs China; Dollar Vs Yuan; Inflation Vs Deflation

The leaders of the G-20 nations will meet next month in Seoul to attempt to defuse tensions over competitive devaluation by governments — the currency war of the tabloid headlines — that their central bankers and finance ministers were unable to resolve at last weekend’s annual meetings of the International Monetary Fund and the World Bank. At this point the prognosis is not good. The consensus and cooperation that was there at the start of the global financial crisis continues to evaporate.

Host South Korea, as Japan’s finance minister has mischievously pointed out, is one of the countries that “regularly” intervenes in foreign exchange markets, but it is China’s foreign exchange-rate policy that will be the elephant in the room, as it was at the IMF meeting. The pace of the yuan’s appreciation against the U.S. dollar since China again loosened its peg with the greenback in June (2.4%) has been insufficient for the critics who accuse China of keeping the yuan cheap to protect its exporters.

If China’s most recently posted trade surplus of $120.6 billion dollars in the first nine months of 2010, 10.5% lower than in the same period a year earlier, hasn’t assuaged China’s critics, then the largest quarterly increase in the country’s foreign exchange reserves in the third quarter, $194 billion, thanks to the persistently large trade surplus and capital inflows, is only likely to inflame them, providing further evidence that the yuan is undervalued.

The new factor is the beggaring of neighbours. U.S. Treasury Secretary Timothy Geithner says that that the yuan’s undervaluation is forcing other developing countries that supply China to attempt to halt the appreciation of their currencies, too. What Geithner did not say was that it halting his country’s attempts to devalue its way to export growth, too. For those with even longer memories than ours, the calamitous competitive devaluations of the Great Depression come into prospect.

Beijing has been candid about the damage it believes a rapid upward revaluation of the yen would to do its exporters, citing that as its reason for moving cautiously. It continues to remind anyone who will care to listen, though its words mostly fall on deaf ears in the rich countries, that there are other sources of the current global imbalances, such as huge fiscal deficits and unconventional monetary policy in the developed economies.

We are likely to be hearing more of that refrain. In the U.S., the Federal Reserve is expected to embark soon on another wave of flooding the U.S. economy with money, the so-called second round of quantitative easing (“QE2”). The Fed’s strategy for stimulating a recovery that is stubbornly sluggish, if not unexpectedly so given the de-leveraging the U.S. economy has undergone, is to inflate the economy and depreciate the dollar by a combination of running negative real rates (nominal rates are already as close to zero as makes no difference) and quantitative easing.

This is not with our risk. So much world trade is denominated in dollars, as the only global reserve currency, that price inflation of commodities like oil is inevitable. That may not worry Americans so much (yet; but wait for $200 crude), as fighting off deflation is their immediate concern, but it sure worries emerging economies that are not natural-resources exporters, such as China, where inflation is the more pressing concern.

The double hit that quantitative easing in developed economies lands on emerging economies is that it will increase their inward capital flows, potentially inflating asset bubbles, making more probable further intervention in foreign exchange markets to forestall that. The Institute for International Finance forecasts net capital inflows into emerging economies of more than $800 billion in 2010 and 2011.

Governments usually respond to such potentially disruptive capital inflows with some mix of the three policy tools they have available to them: intervention in foreign-exchange markets; the imposition of taxes and controls on the capital flows directly; or doing nothing–letting their currency appreciate and take the hit to their export competitiveness. Neither is a particularly palatable choice, particularly for export-driven emerging economies. We are likely to see all three in some form if the “currency wars” continue.

The long-term solution is well-known,  high-spending, high-deficit developed economies need to get their fiscal houses in order while the real exchange rates of the surplus economies need to appreciate and domestic demand expanded to offset the effect on exports. Getting there is the difficult part.

Not only has the journey barely begun, the kids are already bickering in the back seat. Instead of the sort of co-operation among governments that marked the early days of the global financial crisis to coordinate an orderly adjustment of exchange rates and external accounts (pace the IMF pulling an unlikely rabbit out of the hat before the G-20 summit), each is starting to go its own way. The U.S. is resorting to the instant creation of money, as it uniquely can as it has the world’s only reserve currency (oh, that we could all increase our bank accounts at the touch of a button as the Fed can). China is resisting in the way it knows best, controls, in this case on its exchange rate by having its central bank tightly manage the bands in which the yuan can move.

At the same time, China’s leaders, who have a historic fear of inflation and who know well what it can do for ill to the country’s rulers, believe that the way to make the underlying adjustments to real exchange rates that everyone agrees is necessary long-term is through falling domestic prices in the U.S. That would be similar to the sort of deflationary austerity on the U.S. that is being wished on Greece. That may not be politically acceptable in the U.S. any more than inflation would be politically acceptable in China. But inflating away the world’s global imbalances vs deflating them away are fundamentally opposite policies. The standoff between the two is worsened because deflation in the U.S. would be as bad for China as inflation in China would be for the U.S.

Both threaten to send the global economy into reverse. That all makes a G-20 agreement on exchange rates ever more necessary as a dampener on rising protectionist spirits in the developed economies and the rising nationalism in China among those who see the economy as primarily a matter of national security.  When elephants fight, as the Swahili saying goes, the grass gets trampled. Unfortunately, that doesn’t make an agreement in Seoul any more likely. The best that can be hoped for is that the grass will be left in good enough condition to spring back up again.

This post was first published on Market Bystander.

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China’s Euro Plan

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Europe is getting the same public message from Beijing on yuan revaluation as the U.S.: “Back off and let us deal with it in our own time.”

Prime Minister Wen Jiabao told E.U. officials in Brussels (left) that a big shift in the value of the Chinese currency could create “social and economic turbulence” in China (exporters going bust, migrant workers returning home, Party’s legitimacy undermined…OK, so he didn’t actually say the last bit). But Wen did say that such dislocation would be bad for the world. China was still intending to make its exchange rate regime more flexible, but would do so to its own timetable, Wen said. (Full text of speech)

That is the oft-repeated line that is overtaxing the patience of China’s critics in the E.U., just as it is their counterparts in the U.S. who accuse China of keeping the value of the currency low to help Chinese exporters. Yet, ahead of the annual meetings of the IMF and the World Bank, Wen has also expressed China’s support for the euro, which has gained more than 30% against the yuan since 2001 and 13% since June. And the stops on his European tour are instructive, Greece, Italy and Belgium among them, three of the eurozone’s most indebted countries, but whose paper, along with that of other euro danger cases, Ireland, Spain and Portugal, Wen says, China will readily buy when it starts being issued again.

China doesn’t want a euro crisis, or worse, a collapse of the currency regime for two reasons. First, it would devastate a key export market where recovery, where it has happened, is sluggish at best. Second, it would leave the dollar as the unchallenged world currency, giving Washington an unpalatable degree of control over the global financial system for Beijing’s taste. So it needs a euro robust enough to be an alternative to the dollar, and will do what it needs to prop it up. Nor will Beijing be sorry to be holding high-yielding Euro sovereign debt, providing the euro survives its current crisis unscathed. The question is, will it. China may have a political strategy for the euro, and the euro itself may be a political creation, but the currency still has an economic dimension, too.

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