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What did China do, and how did the United States respond?
After months of signaling that it wanted its currency to be stronger than seven yuan to the dollar, China reversed course and let the yuan depreciate beyond that threshold on Monday. It then fell to an eleven-year low against the dollar.
China has several ways of managing its currency but uses two primary tools to do so on a daily basis. First, the central bank sets a daily reference rate for its currency. And second, the central bank—or state banks acting on its behalf—buys or sells dollars. The central bank has to intervene to keep the value of the currency within a daily trading band defined by the reference rate. Within that band, the price is ostensibly set by market forces, but the central bank can still intervene, and the market watches where the central bank sets the reference rate (“the fix”) for signals.
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When China unexpectedly set the daily reference rate on Monday at a level that was weaker than the market expected, the yuan fell sharply. And after that fall, the United States said it would name China a currency manipulator. China has since signaled that it doesn’t want the yuan to move much further.
Did China manipulate its currency?
It depends who you ask. President Donald J. Trump sometimes calls any currency move that he doesn’t like “manipulation.” He prefers currencies to move in ways that shrink U.S. trade deficits. When the currency of a country with a bilateral trade surplus with the United States, such as China, falls in value, Trump tends to complain about manipulation.
Economists usually use a narrower definition of manipulation. They say that it occurs if a country that runs a large overall trade surplus buys foreign currency, often dollars, to keep its currency from rising in value, because that weaker currency gives its exporters an edge. That is the definition that I use.
By this definition, China isn’t a manipulator. It doesn’t currently have a large current account surplus, and it hasn’t been buying foreign exchange. China actually sold some foreign exchange last fall, and it has neither been buying nor selling large sums this year.
Legally speaking, the issue of whether China meets the standard for manipulation set out in U.S. law is complex. The 2015 Trade Enforcement Act sets out three criteria a country must meet to be tagged a manipulator: a bilateral surplus with the United States, an overall current account surplus, and one-sided intervention in the foreign-exchange market to suppress the value of its currency. The Treasury Department’s most recent report [PDF] concluded that China only met the bilateral surplus criterion.
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But the 1988 Omnibus Foreign Trade and Competiveness Act [PDF] has a different definition of manipulation, saying it can emerge either from action to “[impede] effective balance of payments adjustments” or action to “[gain an] unfair competitive advantage in international trade.” The United States is likely to argue that the recent depreciation was intended to give Chinese exports an edge. China would counter that it has no obligation to resist market pressures pushing the yuan down when the United States implements tariffs that hurt China’s exports.
Trump has called for the Federal Reserve to cut interest rates so that the dollar will fall. Isn’t this currency manipulation?
Not in my view. Manipulation requires intervention in the foreign-exchange market. Domestic interest rates do affect currency values—raising rates lifts a currency’s value, and cutting rates pushes it down—but their main impact is to change the domestic cost of borrowing and the domestic return on saving.
The Group of Seven (G7) discussed this in 2013. The G7 agreed that a country could loosen domestic monetary conditions by buying its own bonds (known as quantitative easing, or QE) but could not target exchange rates by buying foreign currency. That makes sense; countries should be free to set interest rates to serve their economies, but there should be limits on beggar-thy-neighbor policies that lower your currency to boost exports.
Where does the United States go from here?
Naming China a manipulator has no direct consequences. The 1988 law only requires the United States to negotiate with China. The real questions are how China will respond and what new sanctions the United States might impose.
If China holds the yuan around its current level, the United States might not take significant action. The consequences of naming China a manipulator would then be minimal. But suppose China lets the market push the yuan down further. The United States could then respond, at least in theory, by intervening in the foreign exchange market to push China’s currency up. This option would be challenging though. The United States has never intervened in the market for yuan before, and the funds it has to do so are limited. The real threat is likely that any further depreciation by China would be met by higher U.S. tariffs and an expanded trade war.