Currency Manipulation of the 21st Century: China and the US

                           Currency Manipulation of the 21st Century: China and the US

Now more than ever, countries feel tempted to engage in a ‘currency war’ and go back and forth trying to devalue their currency in efforts to encourage exports. The two largest economies, China and the United States, seem to be in a long, bitter trade dispute as the trade relationship is significantly imbalanced. From tariffs to currency, trade tensions are clearly escalating with both sides slapping substantial tariffs on each other’s goods. Currency manipulation (arguably the world’s most protectionist international economic policy) refers to the concept of countries artificially lowering the value of their currency to achieve an unfair competitive advantage (Forbes). The U.S. Dollar is the most popular reserve, and everyone wants a stake in our economy. Unlike many other countries, China does not have a floating exchange rate and instead it pegs its currency to the US Dollar. However, it is not always possible to simply sell off and buy up all of your currency, so the IMF was created to keep the system going (Shirk Lecture 16). The IMF remains ineffective in exchange rate reforms, exacerbating the global trade imbalance as seen with China and the US. The IMF was originally founded to step in and save any currency that was nosediving and make it more valuable. Much of their work has resulted in failure, so they must attempt to stay relevant and effective against economic powerhouses like China. There needs to be more action taken to ensure this dispute does not result in a global currency crisis with devastating consequences to both countries. The IMF suggests the yuan is 13.4% above its 15-year average while the dollar is up 10.3% (Forbes). In other words, the yuan seems to have appreciated more than the dollar in recent years. President Trump has accused China of falling short of the WTO’s requirements and retreating from free trade. This raises a growing concern for the United States because if their currency is too weak, China will have cheaper goods, thus making it easier for them to sell goods abroad. We would have to depend more and more on Chinese goods, thereby surging the U.S. trade deficit. China’s surplus is already rising rapidly, so the intervention of the IMF is needed now more than ever. 

Over the years, there has been ongoing debate surrounding whether or not China will start a currency war against the United States. In 2019, the US has accused China of attempting to weaponize their currency. President Trump raised the stakes to a 10% tariff on $300B in Chinese goods. This provoked China to retaliate by lowering the value of the Yuan below its 7 to 1 peg against the dollar (Investopedia). A major political move within itself, Trump dubbed China a ‘currency manipulator’ for deliberately weakening the Yuan to a historic low. It is hard for the United States to single out China as a trade manipulator when many of the U.S. trading partners (like Russia, for example) follow suit. Forbes states that “about 20 countries, most notably China, have engaged in such practices over the past decade at an annual rate that has averaged $1 trillion in recent years”. China holds a big chunk of U.S. debt (more than $1 trillion)

The Cohen reading talks about how influence can be increased through the use of newly acquired reserves to threaten to devalue the stability of the dollar. At any given time, Beijing could undermine America’s money by dumping US debt on the world’s currency exchanges. It seems to be in their best interest to support the US dollar. The Chinese understand that any depreciation of the ‘greenback’ would impose costs on China as well: greater capital losses on its remaining holdings. Cohen warns that “for every 10 percent depreciation of the greenback, China would lose something in excess of 3 percent of GDP – no small amount”. Despite there being clear advantages for China, the balance of monetary power has not necessarily tipped in favor of China and other surplus countries. There is this ‘balance of financial terror’ that we need to maintain in order to forestall a doomsday scenario (a MAD outcome). China is in a great position to use their influence to manipulate a key currency (like the dollar) even more with the possibility of destabilizing a national regime. Both Russia and China have been working to reduce their dependence on the US dollar which, in turn, causes the U.S. to need China more than China needs the U.S. As shown, surplus countries like China and Russia have growing global influence allowing them to manipulate technology and weaponize cryptocurrency. This ties into the Russia-Ukraine War because Russian elites are trying to use cryptocurrency to dodge sanctions. China’s growing influence leads them to believe that overtaking the US economy within the next 15 years is within reach. 

The dollar tends to be a counter-cyclical currency, meaning if the growth of the rest of the world is climbing, the value of the dollar will dip. The inverse (the US economy being in the lead) is what drives President Trump to impose more tariffs on Chinese exports to increase demand for the US dollar and strengthen it. This will cause a lot of problems for the United States because they will remain dependent on their investors like China unless there are effective new constraints put in place on devaluation policies. Therein Lies a significant geopolitical risk as the two countries continue to butt heads and edge closer to a currency war, driving further market volatility. 

Global imbalances cause a shift in monetary power as well. Cohen goes on to call currency manipulation a double edged sword that could have serious repercussions on China’s economy, despite the significant benefits. As Forbes contributor Randy Brown puts it, currency wars are a risky zero-sum game. Brown states that “any waiting game gets dangerous as economic and market confidence can quickly erode, leaving little room for catch-up political action to shift the momentum”. This stresses the need for international organizations like the IMF to act before it becomes a full-fledged trade war.

It is important for the US to be on the lookout for the possible sell-off of China’s holdings of US debt as a way to retaliate against trade tariffs. If China were to sell a chunk of its holdings, this could trigger US interest rates to increase and hamper economic growth. However, it does not seem like a major concern for the US because it will pose major risks for China as well if they trigger a sell-off in the bond market. The US and China have already entered Phase 1 of negotiations, but the IMF needs to see the trade deal through to the end in order to ease global uncertainty. Both sides must reach a deal that addresses the structural problems in the trade relationship. 

Sources:

What you may not know about China and currency manipulation (brookings.edu)

In A U.S.-China Currency War, Who Wins? (forbes.com)

Currency Manipulation: Why Something Must Be Done (forbes.com)

Why China's Currency Tangos With The USD (investopedia.com)