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Treasury Department Issues Currency Manipulation Report; Focus on China

The United States Treasury Department issued its biannual report on currency manipulation, identifying those nations it suspects of tinkering with the market value of its currencies. The report also detailed the empirical challenges that confront the confident assessment of currency manipulation of foreign trading partners.

The Treasury Department report contends that China remains engaged in currency manipulation, on the basis of the distance between its reported trade surplus and the analytical estimates of that figure espoused by its trading partners. According to the report: “The discrepancy between the estimate of China’s trade surplus reported by Chinese authorities and by China’s trading partners has been investigated in a number of studies. One difficulty that arises is that much trade to and from China travels via Hong Kong. Importing countries usually accurately determine the source of their imports through certificates of origin. But exporters (both Chinese and partner country exporters) often record the destination of their exports as Hong Kong, even though the goods go on to other markets. This explains a significant part of the discrepancy between Chinese and partner country trade estimates of China’s trade surplus, since a significant part of the trade between China and partner countries is recorded as trade with Hong Kong.”

Also, the sudden and dramatic depreciation of the Chinese yuan strongly indicates monetary intervention on the part of the country’s central bank. In 2013, the yuan rose 2.9% against the U.S. dollar, but in 2014 it reversed that course, and dipped 2.68% in value. According to the Treasury Department report, the unpredictable pendulum swings of the yuan, combined with the fact that it “remains significantly undervalued,” both count as evidence of “large-scale intervention” that “could reflect an effort by the authorities to maintain a given exchange rate level in the face of market pressure.”

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Despite South Korea’s lack of full financial disclosure the Treasury Department discovered reasons to believe its central bank put artificial brakes on the rise of its currency, presumably to aid the competitiveness of its export industry. “Although Korea does not publish data on its foreign exchange intervention, during the second half of 2013 the Korean authorities are believed to have intervened to limit the pace of won appreciation. Korea’s foreign exchange reserves rose from $315.6 billion at end-June 2013 to $335.6 billion at end-December and $341.0 billion at the end of February 2014. The Korean authorities also increased their net forward position by $4.9 billion to $50.5 billion over the second half of 2013. The magnitude of these changes is larger than can be reasonably expected from simple interest earnings on the existing stock of reserve assets or valuation changes.”

The report stated that Japan largely permitted market forces to determine the value of its currency and has eschewed any forays into the foreign exchange market for more than two years. “Japan maintains a floating exchange rate regime. As of February 2014, Japan’s foreign exchange reserves were $1.2 trillion, the second-largest in the world.” The analysis continued, “Japan has not intervened in the foreign exchange markets in over two years, although the authorities did issue numerous public statements regarding their desire to “correct the excessively strong yen” in the weeks following Prime Minister Abe’s election on December 16, 2012. Shortly thereafter, in the G-7 statement of February 2013, Japan joined the other G-7 countries in pledging to base its economic policies on domestic objectives using domestic instruments, and to avoid targeting exchange rates. “The euro has experienced significant volatility, in part because it’s mainly allowed to float freely against other currencies. The euro area has a freely floating exchange rate. The euro has experienced large fluctuations since the financial crisis resulting from ebbs and flows in risk aversion associated with financial stresses in the euro area. In the second half of 2013, the euro appreciated by 5.3 percent against the dollar and has been relatively stable through the first three months of 2014. On a real effective basis, the euro depreciated by 0.7 percent in the second half of 2013.”

As many experts have recently noted, the real danger facing the euro is historically low inflation that could potentially convert into deflation. “However, significant macroeconomic and financial headwinds persist. While the pace of fiscal consolidation has eased, the region’s fiscal stance remains contractionary, and bank deleveraging, low real wage growth, and weak investment continue to weigh on economic activity. Moreover, growth was driven primarily by net exports in 2013. With inflation in the euro area dropping to new record lows in recent months and the risk of further financial volatility in emerging markets having an adverse impact on global demand, Europe faces the risk of a prolonged period of substantially below-target inflation or outright deflation. This would slow Europe’s return to growth, further hinder the internal rebalancing that is still needed between the core and periphery, and increase the real burden of public and private debts.”

The report acknowledged the investigative difficulties in determining whether a nation engaged in currency manipulation, given the dynamic constellation of factors involved in such a determination. “The assessment of whether an economy is manipulating the rate of exchange between its currency and the U.S. dollar for the purposes of preventing effective balance of payments adjustments or gaining unfair competitive advantage in international trade is inherently difficult. The determination of exchange rates reflects the interplay of macroeconomic and microeconomic forces throughout every corner of the world.”

Although the Treasury Department cited China as the most egregious example of currency manipulation among the ten countries appraised, the report still “concluded that no major trading partner of the United States met the standard of manipulating the rate of exchange between their currency and the United States dollar for purposes of preventing effective balance of payments adjustments or gaining unfair competitive advantage in international trade…”