When the United States declared China a currency manipulator recently, long-building trade tensions between the world’s two largest economies spread to the combustible realm of currencies, with potentially huge consequences for the global financial system should the escalation continue.
By beginning of August, the escalation has reached a stage where central banks in India, New Zealand and Thailand already cut interest rates, aiming to protect their economies from the fallout of the escalating trade and currency war. And bad numbers on industrial production in Germany heightened fears of a recession in Europe. Money flooded into safe assets, especially United States Treasury bonds.
But in our opinion the wave of worry around the world has its roots in the increasingly fraught relationship between China and the United States. Did China allow the value of its currency, the renminbi, to fall against the dollar simply so it would better match the nation’s economic situation, as the country’s leaders and many international economists argue? Or was it, as President Trump contends, an effort to give Chinese exporters an unfair advantage in trade?
If a factory in China makes furniture for instance, a decline in renminbi against the dollar gives it an advantage in selling to the United States.
That clash reflects Mr. trump’s rejection of the consensus of global economic policymakers, which says countries should be free to set monetary policies aimed at generating sustained growth, even if that causes their currency to depreciate. There’s also a general agreement stating that nations should be free to manage their exchange rates so long as they keep them broadly in line with their economic fundamentals.
The conflict also reflects the president’s singular focus on reducing trade deficits, which he has argued make the United States a loser in the global trade system. But waging a currency war in our opinion could come at a big cost.
We further worry that it undermines the international framework which has supported faster growth for decades. Exchange rates in our opinion have become more and more the shock absorber in the global economy.
When a nation enters a recession, for example, its currency tends to fall, which helps its exports industries and can help lessen the severity of the recession or create a pathway out of it. There have been international strains over currency valuations for years, and they have intensified in a world in which all the major economies are coping with sluggish growth. But the newest currency frictions in our opinion are different.
Up until now, countries have been focused on stimulating their domestic economies. In particular, central banks have cut interest rates and taken other steps to pump money into their financial systems, actions that tend to lower the value of their currency. After all, investing in a currency with lower interest rates is less attractive, all else equal, than in one with higher rates.
But the conventional wisdom among international economists is that this does not count as currency manipulation. It’s not a game in which one country’s win means another’s loss. Lower interest rates should generate more economic activity, which makes the whole world better off.
The Trump administration in our opinion has introduced a zero – sum approach to global currency policy – envisioning a loser for every winner – that violates the spirit of those rules. In that sense, the latest moves risk upsetting a relatively stable order, creating unpredictable ripple effects. When currencies swing wildly, entire economic sectors can be crushed even in powerful nations if those sectors find themselves uncompetitive after a shift in global exchange rates. And it could in our opinion undermine the central role the United States has played in the international financial system, especially if the accusations of manipulation are followed up with concrete retaliation to try to artificially depress the value of the dollar.
The dollar being the primary global currency has enormous benefits for the US, but with the side effect that when the US tries to depreciate, there are in our opinion limits on how much it can do that. If the US abuses its privilege too much by bullying, there will eventually in our opinion be a switch.
The recent decision to name China a currency manipulator does not, in and of itself do much. But it could be followed up with pressure on the International Monetary Fund (IMF) and other nations to make similar findings and lean on the Chinese to adjust their policies. Or it could lead to direct intervention in foreign exchange markets by the United States Treasury. And this is also not the first time President Trump has accused a major trading partner of using currency policy to mistreat the US.
He assailed the European Central Bank for moving toward monetary stimulus in June – complaining on Twitter that the resulting drop in the value of the euro was “making it unfairly easier for them to compete against USA.”
The European Central Bank explained its stimulus as an effort to keep Europe from sliding back into recession. When the central bank first undertook its “quantitative easing” policies, it was with encouragement from the Obama administration which believed a stronger European economy was ultimately good for the United States economy, despite its effect on currencies.
Similarly, the Trump administration’s decision to name China a currency manipulator – for allowing the value of its currency to fall – does not align with how mainstream economists view China’s move.
With the economy slowing in China, in part because of the trade conflict, market forces tend to push its currency lower. But the People’s Bank of China has defended the currency from big drops, aiming to prevent capital from flowing out of the country or destabilizing the world economy.
The “manipulation” that took recently place wasn’t in our opinion artificially depressing the Chinese currency to seize advantage with trade partners, but engaging in less manipulation to allow it to fall closer to its market-determined rate.
There is a more nuanced case to be made against Chinese currency policy – which it did intervene for years to push down the value of its currency, ending in the early 2010s, and that Chinese economic might was built on an unfair practice. But the Trump administration’s announcement focuses on the more recent actions, in which in our opinion different economic rationales apply.
There is also a paradox for President Trump. Because of the dollar’s unique role as the global reserve currency, when panic sets in overseas, money tends to flow into United States Treasury bonds, which are so far viewed as the safest assets on earth. But that movement tends to prop up the value of the dollar and push overseas currencies lower. In other words, the more chaos he injects into the global economy by trying to pressure China, Europe and others not to depreciate their currencies, the more upward pressure there will be on the dollar, undermining those efforts.
This is in our opinion potentially the worst of both worlds. When the dollar rises on currency markets because the United States economy is booming, it may be hard on American export industries, but at least it takes place in the context of strong growth.
But for the dollar to surge because of global economic troubles, it means exporters suffer at the same time that the overall economy is under pressure. A particular extreme example of this happened in the fall of 2008, when the United States economy was in free fall and yet the dollar rose because of the global financial crisis.
If the Trump administration continues down the path of using currency policy to try to bludgeon China over trade, technology and national security issues, it will signal a remarkable expansion into a policy area that has been a source of stability in recent decades. It’s dangerous in our opinion to start a currency war because no one knows where it will end. We’ve seen with the trade conflict that it started in one place, and ended up much broader. There’s in our opinion every risk a currency war will do the same.