Mnuchin and Manipulation of Money

US Treasury Secretary Steven Mnuchin already finds himself hemmed in on all sides. 

Domestic constraints come from the promises that he and President Trump have made and the laws of arithmetic.  How, for example, is he ever going to be able to reconcile the specific tax proposals that candidate Trump campaigned on with the promise of the “Mnuchin rule” that taxes won’t be cut for the rich?  That is even harder than the traditional conundrum that faces Republican Treasury Secretaries: having to explain how massive tax cuts (to which they are truly committed) can be reconciled with a reduction in the budget deficit (to which they claim to be committed).

Many of his predecessors found that they had more latitude in the international part of their job than the domestic part.  Their voice would often receive more respectful hearings from their foreign counterparts on the international stage, at multilateral meetings like the recent G-20 gathering in Baden-Baden, than from domestic political players in Washington. 

But Mnuchin will have a harder time in the international context.  To begin with, the current Administration has indicated in many ways that it no longer wants the job of leader of the global system.  The leader is the one who persuades other countries that certain agreed-upon rules, such as an open trading system, are in everybody’s interest.  The Trump administration has no interest in playing that role.  Its view is that the appropriate thing to do in international negotiations is to make unilateral demands. 

It is fortunate that Mnuchin realized that the scheduled opportunity to name China a currency manipulator comes in April, when the biannual Treasury report to Congress is due, rather than, the day that Trump assumed the presidency as promised.  But he should pass on the opportunity.  He needs to explain to his boss that China is no longer manipulating its currency, preferably in time for Trump’s meeting with Chinese President Xi Jin Ping, scheduled for April 6-7, at Mar-a-Lago.   President Trump has explicitly re-asserted his earlier campaign allegations of manipulation by the Chinese.

“Deal-makers” don’t do well with ill-informed bluster that they are subsequently forced to back down on.  This principle was illustrated when Trump challenged the “One-China” policy in December but was then unsurprisingly forced to reverse himself, in a February 9 phone call with President Xi.  Unpredictability is not always an advantage, as he seems to think.  Chinese know the difference between a bargaining chip and loss of face.  Trump is now that much weaker in dealing with China.  A leader who has a very good brain should learn the lesson.

Is China manipulating its currency?  The language regarding “manipulating exchange rates” originated in a 1977 decision by IMF members. Of the various criteria to determine whether a country is guilty of intentional manipulation to gain competitive advantage and frustrate balance of payments, the sine qua non is the systematic purchase of foreign exchange reserves to push down the value of the national currency (“protracted large-scale intervention in one direction in the exchange market”).  The other two criteria are the partner’s current account balance and the value of its currency (e.g., judged by international price competitiveness relative to an appropriate benchmark). 

Those are the three criteria in international law.   The US Treasury’s biannual reports to Congress on foreign exchange policies of major trading partners were originally mandated in a 1988 law, later “intensified” in a 2015 law.  The Treasury is directed to include the country’s bilateral trade balance vis-a-vis the US as one of the three criteria, even though bilateral balances per se play no role in either the IMF rules or economic logic.  (That the US runs bilateral trade deficits with many countries has far more to do with factors other than their currency policies.  For one thing, the US runs a trade deficit overall because it has a low rate national saving.  This is bound to worsen under Trump fiscal policies.)  A statistical analysis of Treasury decisions regarding whether to name countries as possible manipulators in particular reports shows a significant role for the US unemployment rate in election years, along with the bilateral balances.

It is true that the RMB was undervalued in 2004 (by roughly an estimated 30%), according to a wide variety of criteria.  But as of today China no longer qualifies as a currency manipulator under any of the three internationally accepted criteria:  exchange rate level, trade balance, and use of foreign exchange reserves.  The RMB appreciated 37% between 2004 and 2014 (on a real broad trade-weighted basis).  Its trade surplus, after peaking at 9% of GDP in 2007, then adjusted to the receding price competitiveness: the surplus has been less than half that level each year since 2010.  

Furthermore in 2014 – as the Chinese economy slowed relative to the US economy -- China’s capital inflows turned to capital outflow.  As a result the overall balance of payments went into deficit.  Foreign exchange reserves peaked in July of that year and have been falling since then.  The People’s Bank of China, far from pushing the renminbi down, has spent a trillion dollars of reserves over the last three years trying to support the currency in the foreign exchange market, by far the largest such intervention in history.  The authorities have also tightened controls on capital outflows, again with the objective of resisting depreciation. They have succeeded, in the sense that despite some adverse fundamentals the RMB has continued to be one of the world’s more appreciated currencies, second only to the dollar and a few others that are even stronger.

These points are not new.  True, it took a while for most American commentators to notice the sea change in China’s foreign exchange market.  By now it has been three years and most observers have figured it out.  But not the US president.

Some other Asian countries meet one or the other of the manipulation criteria.   Korea’s trade surplus has been running at around 7% of GDP and its current account even higher; but it is not piling up foreign exchange reserves the way it was several years ago.  Similarly with Thailand.  It is not clear if there is an Asian country that meets all the criteria.

Peter Navarro, director of Trump’s new National Trade Council points the finger at Germany, saying it "continues to exploit other countries in the EU as well as the U.S. with an ‘implicit Deutsche Mark’ that is grossly undervalued".   It is true that Germany’s trade surplus is a big 8% of GDP and the current account surplus close to 9%, which is indeed excessive.   But Germany has not had its own currency since the mark gave way to the euro in 1999. The European Central Bank has not operated in the foreign exchange market in many years; and when it did, the intervention was to support the euro, not push it down.

Given the absence of direct foreign exchange intervention among G-7 countries, those who allege currency manipulation suggest that some governments are doing other things to keep their currencies undervalued, particularly expanding the money supply.  Of course central banks do engage in monetary stimulus knowing full well that one effect is likely to be a depreciation of its currency and a stimulus to its exports.  But one has to keep pointing out that:

1. Countries have the right to use monetary policy to respond to domestic economic conditions.
2. In normal cases, it would require a mind-reader to know whether currency depreciation was a major motivation for the action,
3. A successful monetary stimulus will also raise income through domestic channels and thereby raise imports, so that the net effect on the trade balance could go either way, and
4. If other countries don’t like the exchange rate and trade balance results, they are free to undertake monetary expansion of their own.

In 2010-11, these were the arguments that were given (correctly) in defense of the Fed’s quantitative easing and the dollar’s depreciation, when Brazilian leaders accused the US of waging “currency wars.”  They are just as valid when other countries are the ones needing monetary stimulus.

The Trump administration’s accusation against Germany is a uniquely foolish instance of manipulation allegations.  It is true that the European Central Bank responded to the 2008-09 global recession (belatedly) by lowering interest rates and undertaking quantitative easing, and that this contributed to a depreciation of the euro.  But it has been plain for all to see that Germany has consistently opposed the ECB’s monetary stimulus.  One does not have to read the minds of the German officials to see that a charge of manipulation would be nonsense.

Other forces have been working to weaken foreign currencies against the dollar.  Perhaps the biggest in the last five months has been Donald Trump  himself.  His talk of raising tariffs against Mexico, China, and other trading partners has worked to depreciate those currencies against the dollar.  The proposal for a Border Adjustment Tax has the same effect.  Finally, Trump has promised big tax cuts and they are likely to pass Congress -- though he unintentionally delayed his tax plans substantially, by putting Obamacare repeal first.   The result (not promised) will be a rapid acceleration in the national debt, which will probably force up interest rates, the dollar, and the trade deficit.

The multilateral calendar includes a G-7 leaders meeting in Sicily in May and a G-20 summit in Hamburg in July.  Mnuchin’s unenviable task is to acquaint Trump with reality by then.