China’s RMB Exchange Rate Issue Needs Objectivity

By Yu Xiang

On February 24, hours after his new Secretary of Treasury, Steven Mnuchin, pledged a more methodical approach to analyzing China’s foreign exchange policy, US President Donald Trump publicly criticized China, labeling the Chinese as the “grand champions” of currency manipulation.

Trump’s declaration arouses concern that more disputes between China and the United States lie ahead. For the two largest open economic entities, the foreign exchange rate is an important policy issue. The handling of currency and foreign exchange rate issues must be approached with caution, particularly if it involves labeling a “currency manipulator.”

China’s reform efforts in regard to the RMB exchange rate should be taken into serious consideration. China has been dedicated to reforms directed toward market-oriented principles. .

The Chinese government in July 2005 announced reforms to its currency policy. China immediately appreciated the RMB against the dollar by 2 percent and moved to a “managed float” exchange rate system, setting the RMB in the basket of major foreign currencies that included the US dollar and other major currencies. On August 11, 2015, China’s central bank announced it was taking measures to improve the market-orientation of its daily central parity rate of the RMB. From June 2005 through July 2015, the RMB appreciated 35.3 percent on a nominal basis against the dollar. From July 2015 to mid-December 2016, the RMB depreciated by 14 percent against the dollar, a reflection of slowdown experienced by the Chinese economy.

It’s obvious the RMB exchange rate could, to a large extent, reflect the reality of market changes and macroeconomic trends. For this reason, the International Monetary Fund (IMF) publicly confirmed China’s reform of the RMB exchange rate. The IMF assessed the RMB to be “no longer undervalued” in May 2015 and stated the RMB was “assessed as broadly in line with fundamentals” in July 2016.

The US Trade Facilitation and Enforcement Act of 2015 clarifies provisions on monitoring and addressing foreign exchange rates, and lists new enhanced factors for the US Treasury to consider when a country is labeled a currency manipulator. The benchmarks established by the US Treasury include:

• having a bilateral trade surplus larger than $20 billion;
• having a current account surplus exceeding 3 percent of GDP; and
• engaging in persistent one-sided intervention in foreign exchange markets resulting in net purchases equal to 2 percent or more of GDP over the past year.

China met two out of the three criteria (large trade surplus and current account surplus over 3 percent of GDP), according to an April 2016 report. The Treasury’s October 2016 report stated China had met only one of the criteria (large trade surplus). Therefore, by US standards, China is not a currency manipulator.

There is no proof supporting the charge that the RMB exchange rate is the source of the US international transaction imbalance. The US trade deficit with China was $347 billion in 2016. The current account doesn’t give a complete picture of US international transactions. It doesn’t include a large number of financial flows, which could be viewed as “adjustment items”. When we consider the United States’ trade deficit with China, we shouldn’t forget the US’s financial surplus with China.

If the United States insisted on launching a trade war with China by imposing higher tariffs, or labeling China as a currency manipulator and revoking former trade facilitation arrangements with China, it might reduce the direct bilateral deficit, but not the overall US trade deficit. Protective barriers against Chinese imports would merely shift the bilateral trade deficit to other countries while raising prices for US consumers.

On a more positive note, there has been an observable change in Trump’s tone, compared to what he said in the presidential campaign. This signals the possibility of a future policy adjustment. Also dampening Trump’s campaign rhetoric is the division between the president and other key players in the executive branch. Because of this, we expect President Trump’s attitude towards China to be more reasonable in the future.

About the author: China-US Focus is built on the principle that China and the United States hold the most important bilateral relationship of the 21st century. China-US Focus also provides comprehensive resources on current and historical facts and information related to the bilateral relationship. China-US Focus is the only open-platform website where Chinese and American thought leaders can openly express their views on the myriad issues that face the two nations, thus promoting communication and understanding between the peoples of China and the United States.