Last week, Congress received the US Treasury's latest report on the FX policies of our major trading partners. The main purpose of this semi-annual report is to identify foreign governments which are manipulating their currencies to gain unfair advantage in international trade.
There was talk that China, Germany and/or South Korea might be named last week, but none of that came to pass.1 It's notable that while President Trump has personally labeled China a currency manipulator, the US Treasury declined to take that step.
The reason might be as simple as the fact that two out of three necessary criteria were not met
Bilateral trade surplus with the US must not exceed $20 billion (YES - China’s surplus is nearly $350 billion)2
Current account surplus must not be greater than 3 percent of a country’s GDP (NO - China’s is only 1.3 percent)3
Persistent one-sided currency intervention must be observed (NO – the Chinese central bank has not intervened since its surprise devaluation in August 2015; since then, the central bank has been observed propping up its currency rather than driving it down)
The question remains: Should we be concerned that China has not officially been labeled a currency manipulator?
The simple answer is no. The more thoughtful answer is that we would have greater concerns if the US Treasury had taken the bolder step. Here's why:
Traders assume that the Trump administration’s ultimate goal is to prevent China from weakening its currency in order to soften the blow of tariffs. However, branding China a “currency manipulator” in the midst of a trade war would be introducing a potentially volatile new aspect to a complicated and delicate diplomacy. Turning what is now a "trade war" into a "currency war" would likely provoke bedlam in global financial markets, particularly within the Asian currency markets.
The US Treasury did revise its FX “watch list," and that list now includes China as well as Germany, India, Japan, South Korea and Switzerland4. To single out China from this list would send a signal to China and the world, and China would react. We can't say exactly how, but we know that the markets hate uncertainty more than anything.
For the time being, a potential currency war between China and the US has been contained. We can interpret some of the language in the Treasury report to serve as a "final warning." The good news is that we have six months until we find ourselves at this crossroad again, when the Treasury makes its next report to Congress. Until then, it remains to be seen whether inflammatory rhetoric fuels currency movement, and most importantly, whether China will guide its currency up or down. We'll be watching.
Sources: 1, 4 US Department of the Treasury 2, 3 Bloomberg 2018
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Scott Petruska is Chief Currency Strategist and senior advisor for Silicon Valley Bank’s global financial services group, and is based in Boston, MA. He advises clients on currency and interest rate hedging strategies, and helps them with other aspects of global banking. He regularly writes blogs on topics covering the global financial markets, conducts client seminars and webinars, and speaks at regional financial conferences.
Petruska has more than 30 years experience in the currency and interest rate markets, and has lived and worked in Boston, Chicago, New York City, Singapore and Tokyo. Prior to joining SVB in 2009, he worked at several large international financial institutions, including National Westminster Bank, Irving Trust, Bank of New York, State Street Bank and Commerce Bank. He has been an institutional trader, product developer, analyst, salesperson and advisor.
Petruska has been awarded several professional designations, including the CFA (Chartered Financial Analyst), FRM (Financial Risk Manager) and CMT (Certified Market Technician). He earned his undergraduate degree in Finance & Banking from the University of Wisconsin.