U.S. Softens Criticism of Yuan Level Amid Currency Pressures

  • Treasury: Yuan now below `appropriate medium-term valuation'
  • U.S. previously said currency was `significantly undervalued'

The U.S. Treasury dropped its view that China’s currency is “significantly undervalued” while saying that the forces driving appreciation in the longer term remain and China needs to allow such strengthening eventually.

The yuan remains “below its appropriate medium-term valuation,” the department said Monday in its semiannual report on foreign-exchange policies. The “core factors” that have driven the appreciation of the yuan in recent years remain in place, such as a large and growing current-account surplus, and net inflows of foreign direct investment, the Treasury said.

Even so, the department refrained from characterizing China’s currency as “significantly undervalued,” as it has in each foreign-exchange report since May 2012. The Treasury also recognized that with an economic slowdown and stock-market volatility, “market factors are exerting downward pressure” on the yuan, though the department called the trend “transitory.” The International Monetary Fund, by contrast, adopted the view in May that the yuan is “no longer undervalued.”

The softer U.S. stance on China’s exchange-rate policy came in the first currency report by the Obama administration since the People’s Bank of China surprised markets on Aug. 11 with a devaluation that led to the yuan’s steepest two-day drop since 1994. The central bank said it would allow market forces to play a greater role in its daily setting of the yuan’s reference rate.

Regime Test

"There’s really very little they can complain about," Axel Merk, president and chief investment officer at Merk Investments LLC in San Francisco, said of the Treasury. "We’ve moved far beyond what people used to call manipulation."

The Treasury said a test of China’s new regime will be whether the country allows the yuan to “respond flexibly to appreciation as well as depreciation pressures.” It’s critical that China stick to its pledge to intervene in currency markets only when justified by “disorderly market conditions,” the department said.

The U.S. said China intervened “heavily” in the last three months, spending an estimated total of $229 billion to prevent the yuan from falling. China should regularly disclose its foreign-exchange interventions, the Treasury said.

Capital Outflows

Capital outflows from China probably accelerated to $200 billion in August amid the currency devaluation, concern about the nation’s economic slowdown and heightened volatility in its stock market, according to Treasury estimates that don’t include foreign direct investment. Outflows totaled $70 billion-$80 billion in July, and $250 billion in the first half of the year, according to the report.

The department concluded in Monday’s report that no major trading partner met the threshold to be called a currency manipulator.

Under a 1988 law, the Treasury is required to report to Congress twice a year on international economic conditions and exchange-rate policies. The Treasury must enter direct talks with a country deemed to be manipulating its currency, and also seek redress through the IMF. The last country labeled a manipulator was China, in 1994.

The greenback has appreciated 12.2 percent over the last year, according to the Bloomberg Dollar Spot Index. The yuan has dropped 3.7 percent against the dollar over the same period.

Keeping Commitments

Treasury Secretary Jacob J. Lew said earlier on Monday that the yuan still has room to appreciate and that the world’s second-largest economy must abide by commitments not to weaken the currency. “We have to make sure that China understands that it’s very important that they keep their commitment to let the RMB go up as well as down,” Lew said on CNBC television, referring to the renminbi, the currency’s official name.

A “persistent” weakening of the yuan would be inconsistent with the fundamentals of the Chinese economy, PBOC Deputy Governor Yi Gang said at the IMF’s annual meeting in Lima on Oct. 9. China is committed to making its currency regime more flexible and market-based, he said.

China is trying to win IMF approval to join the lender’s basket of reserve currencies, and a decision is expected by year-end.

Undervalued Won

In its report, the Treasury also said the South Korean won remains undervalued, urging Korean authorities to increase the transparency of their foreign-exchange operations and refrain from intervening to push down the currency.

In the euro area, low inflation, low growth and strong reliance on monetary policy remain a risk, and fiscal policies should be employed to support domestic demand, the Treasury said in the report. It “would be much better if Germany and other countries with current-account surpluses took stronger action to boost domestic demand growth,” the department said.

Before it's here, it's on the Bloomberg Terminal. LEARN MORE