Management, Not Manipulation
We believe China is managing, not manipulating, its currency. The country's central bank aims to maintain a stable exchange rate amid trade-related volatility.
The Trump administration labeled China as a currency manipulator after the Chinese renminbi (RMB) fell in value below 7 per U.S. dollar recently. We disagree and believe China was managing rather than manipulating its currency.
It is important to keep in mind the various currency regimes globally. In any country, the value of the exchange rate fluctuates due to changes in numerous variables. Some economies, such as the U.S., opt for a free-floating exchange rate where the movement is set entirely by market forces. Some economies, for example Hong Kong, fix the exchange rate to a very narrow range. Other economies manage the exchange rate to some degree. The RMB is one of the currencies that is heavily managed to reduce volatility (see Figure 1 below). For example, year to date, the RMB depreciated by roughly 2.5%, in line with the rest of the emerging market (EM) countries (see Figure 2 below) and with less volatility than most EM countries.
Amid this context, the responsibility of managing the RMB exchange rate falls to China's central bank, the People's Bank of China (PBOC). The PBOC manages the exchange rate through tools such as:
- Outright transactions using foreign exchange reserves (reserves totaling about US$3 trillion)
- Daily fixings of the RMB exchange rate
- Adjustments to daily fixings such as countercyclical factors (CCF)
- Daily maximum trading bands defined as certain percentage away from the fixing
- Reference to a trade-weighted basket of currencies
- Liquidity operations in the market to control borrowing costs of the RMB
- Capital controls for capital account transactions
- Other administrative-control mechanisms such as increased travel documentation requirements
At the same time, market factors affecting the RMB are the same as those for any other currencies. These include but are not limited to:
- Perceived riskiness
- Perceived economic strength/weakness
- Import/export balance
- Risk sentiment
- Economic-related news
The PBOC's task is to manage the currency in light of market-based factors that affect the exchange rate. What we saw August 5, when the RMB weakened below 7 per U.S. dollar, was one such example. Amid concerns about the negative effect of an escalation in the U.S.—China trade war, market forces caused the currency to depreciate. Given its task is to maintain a relatively stable exchange rate, the PBOC used one of its tools to offset market forces—the aim was not to depreciate the currency but to reduce volatility. As a result, the PBOC acted to appreciate its currency relative to where the market was pushing it. And thus, we believe, that it did not represent a “devaluation” or show signs of competitive devaluation.
Regarding whether China is a “currency manipulator,” we note the U.S. Treasury's own definition (Omnibus Trade and Competitiveness Act of 1988 Sec 3004b). Accordingly, China doesn't meet the definition of a “currency manipulator” (see Figure 3).
China's current account surplus is less than 1% of GDP, much smaller than those of other East Asian countries such as Singapore, South Korea and Vietnam.
In conclusion, we do not think China meets the definition of a “currency manipulator”, nor do we think the country is engaged in a competitive devaluation. On the contrary, we think China is just following its typical modus operandi of managing its currency as it has done in the last few years.
Teresa Kong, CFA