Trump Isn't All Wrong About Currency Manipulation
The Trump administration has come out firing against two major U.S. allies recently, accusing them of currency manipulation. Last week, at a meeting with heads of pharmaceutical companies, Trump mentioned China and Japan:
Every other country lives on devaluation…You look at what China's doing, you look at what Japan has done over the years. They...play the money market, they play the devaluation market and we sit there like a bunch of dummies.
Meanwhile, Trump economic adviser Peter Navarro told the Financial Times that Germany’s trade surplus is a sign that the euro is “grossly undervalued.”
Are Trump and his advisers right? In some ways, yes; in some ways, no.
There’s no doubt that China manipulates its currency. The country ties the value of its currency, the renminbi (also called the yuan), to the value of a weighted average of other currencies; it can only trade within a narrow band set by the government. If market forces try to push the yuan out of that range, the government trades in the foreign-exchange markets until the currency is back within its bounds.
During the 2000s, when the yuan was firmly pegged to the U.S. dollar, almost everyone agreed that China’s currency was substantially undervalued. This helped China to maintain a large trade deficit with the U.S. -- China shipped goods to the U.S., and the U.S. wrote China IOUs in return. That trade deficit contributed to the massive economic dislocation that we now call the China Shock. U.S. workers were hurt, even as the U.S. repeatedly refused to label China a currency manipulator. Trump is probably right that we were dummies.
But in recent years, the situation has changed. The yuan is no longer undervalued. As China’s economy slows and its asset markets look shaky, capital is flowing out of the country. That pushes the value of the yuan down. China still manipulates its currency, but it’s now probably propping it up rather than holding it down. If China ends its manipulation, the yuan will probably get even cheaper, making its goods even cheaper in the U.S.
How about Japan? Trump is also correct in saying that Japan has manipulated its currency over the years -- though the amount of manipulation is far less than what China does. Usually, the Japanese yen floats freely against other currencies. But occasionally, in times of economic stress, the Japanese government has been known to intervene in the foreign-exchange markets. In 2003 and 2004, the Bank of Japan bought hundreds of billions of dollars, pushing down the yen against the U.S. currency in an attempt to give its exporters a boost.
The attempt failed. The yen weakened against the dollar in 2004, but not much, and it didn’t last:
And Japan’s trade surplus didn’t change much at all:
The country largely abandoned its attempts to hold down the yen, even when it started running a trade deficit in the 2010s. A few halfhearted interventions since the early 2000s have had little effect. Currency manipulation, as economic research shows, just isn’t that reliable a tool.
Some allege that Japan’s huge program of quantitative easing via asset purchases constitutes a form of currency manipulation. But this isn’t really right. Theoretically, lower interest rates can cause capital to flow out of a country, weakening the currency and raising exports. But this effect is weak. Japan’s interest rates are already at zero and can’t go any lower, and QE has failed to create any lasting inflation. Money isn't pouring out of Japan, and the country is barely running a trade surplus.
So while Trump is right about Japan’s past, it’s also not an important issue right now.
As for Germany, Navarro’s argument is on pretty weak footing. Germany is one of 19 countries that use the euro, so to say Germany is manipulating its currency is like saying that Texas is manipulating the dollar. What’s true is that the way the euro zone is set up tends to make Germany run a trade surplus with other European nations. Essentially, other euro countries would need to have easier monetary policy than Germany in order balance out the flow of trade -- but they can’t, because there’s only one monetary policy for the whole euro zone.
In other words, Germany’s surpluses are a problem, but they’re a problem within Europe, and they’re due to the setup of the euro zone rather than to the manipulation practiced by China.
So while I sympathize with Trump’s frustration about China’s past policies, and I share Navarro’s concerns about Germany’s trade surpluses, I’m pretty sure that branding these countries as currency manipulators wouldn’t help the problem. It wouldn’t fix the euro’s problems, and it would only make China’s currency even cheaper. And Japan isn’t manipulating its currency anymore. The U.S. should try to improve its trade balance, but fighting against currency manipulation won’t be a very effective strategy at this point in time.
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