Why Trump picked the wrong fight with his designation of China as a currency manipulator
- The Chinese central bank’s decision to let the yuan fall below 7 per US dollar had little to do with trade or currency wars. Rather, it represented an important step towards reforming China’s inflexible exchange-rate regime
After 2003, the PBOC intervened to prevent the renminbi from appreciating, because of fears that a stronger currency would hurt China’s growth. The Chinese authorities de-pegged the renminbi from the dollar in 2005. And following a temporary re-peg during the 2008 global financial crisis, China adopted an exchange-rate regime in 2010 that the International Monetary Fund classified as a crawl-like arrangement.
Since late 2014, however, appreciation pressure on the renminbi has waned. In August 2015, the PBOC tried to take a decisive step from a soft peg towards a floating exchange-rate regime by declaring the central parity of the renminbi’s exchange rate against the dollar would be determined by the previous day’s closing price.
Unfortunately, due to the poor timing of the move, the market overreacted, and the renminbi fell 3 per cent against the dollar in three days. Unnerved by the experience, the authorities hastily abandoned the reform.
Some economists criticised the bank for squandering reserves in order to facilitate capital flight and the unwinding of carry trades (in which investors borrow money in a low-interest-rate currency in order to buy assets in a higher-yielding one).
Most, however, supported the intervention on the grounds that it prevented the renminbi from going into free fall and causing a financial crisis.
In early 2017, the renminbi approached 7 yuan per dollar, sparking a debate on whether the PBOC should let the currency fall past this point. Thereafter, 7 yuan became a psychological threshold.
Whenever the exchange rate approached this level, the PBOC would set a central parity price for the renminbi that was above the market rate, in order to signal that it would not allow the currency to go below 7 yuan.
More often than not, market makers adjusted their bid and offer prices in line with the PBOC’s forward guidance, and depreciation pressures eased.
Why did the PBOC choose this moment? My understanding is that it has been planning for many years to shake off the shackles of the renminbi’s inflexible exchange-rate regime. Having postponed the move time and again, it had to take a decisive step at some point.
Although the PBOC’s gamble appears to have paid off so far, Chinese policymakers are still worried about excessive depreciation.
In fact, in recent days, the PBOC has again tried to prop up the currency by issuing renminbi bonds in the offshore market and using the so-called countercyclical factor to set the renminbi/dollar exchange rate higher than a level in line with the predetermined central parity price-setting rule, to signal its preference for a stronger currency.
To those who have been arguing for decades in favour of a speedy transition to a free-floating exchange-rate regime, these latest interventions are yet another sign of official dithering.
In general, policymakers should let the market determine the renminbi’s exchange rate as much as possible, regardless of whether the currency is facing upward or downward pressure.
At the same time, they should never allow a competitive devaluation of the renminbi for the purpose of gaining a trade advantage. That would not only be unfair to China’s trading partners; it would also undermine the country’s own long-term interests.
By accusing China of currency manipulation, therefore, the Trump administration has clearly picked the wrong fight. On exchange rates at least, its ignorance is astonishing.
Yu Yongding, a former president of the China Society of World Economics and director of the Institute of World Economics and Politics at the Chinese Academy of Social Sciences, served on the Monetary Policy Committee of the People’s Bank of China from 2004 to 2006. Copyright: Project Syndicate