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.
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1, 4 US Department of the Treasury
2, 3 Bloomberg 2018
This article is intended for US audiences only.
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