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China’s RMB Exchange Rate Issue Needs Objectivity

Mar 06 , 2017

Hours after his new Secretary of Treasury, Steven Mnuchin, pledged a more methodical approach to analyzing China’s foreign exchange policy, U.S. President Trump on Feb.24 publicly criticized China, labeling Chinese as the "grand champions" of currency manipulation.

Trump’s declaration arouses concern that more disputes lie ahead between China and the U.S. For the two largest open economic entities, the foreign exchange rate is a very important policy issue. We need to be very careful in handling currency and foreign exchange rate issues, especially in labeling a “currency manipulator”.

In my opinion, President Trump and his administration could and should be rational and objective on China’s RMB exchange rate issue.

To begin with, China’s endeavor to reform regarding the RMB exchange rate should be taken into serious consideration. China has been dedicated to reforms on the RMB exchange rate system. The direction, market-oriented reforms, is very obvious. The Chinese government in July 2005 announced reforms to its currency policy. China immediately appreciated the RMB against the dollar by 2% and moved to a “managed float” exchange rate system, set RMB on a basket of major foreign currencies that included the U.S. dollar and other major currencies. On August 11, 2015, China’s central bank announced it was taking new measures to improve the market-orientation of its daily central parity rate of the RMB. From June 2005 through July 2015, the RMB appreciated by 35.3% on a nominal basis against the dollar. From July 2015 to mid-December 2016, the RMB depreciated by 14% against the U.S. dollar, which is a reflection of Chinese economy’s slowing down. It’s obvious that the RMB exchange rate could to a large extent reflect the real situation of market changes and the macroeconomic basics. That is the reason why the International Monetary Fund (IMF) publicly confirmed China's reform on the RMB exchange rate. IMF assessed the RMB to be “no longer undervalued” in May 2015 and it stated that the RMB was “assessed as broadly in line with fundamentals” in July 2016.

Second, China doesn’t approve U.S.’s own criteria for a “currency manipulator”. The U.S. trade Facilitation and Enforcement Act of 2015 clarifies provisions on monitoring and addressing foreign exchange rates and lists new enhanced factors for U.S. Treasury to consider when one country is named as a currency manipulator. The benchmarks U.S. Treasury established include: First, having a bilateral trade surplus larger than $20 billion; second, having a current account surplus of more than 3% of GDP; and third, engaging in persistent one-sided intervention in foreign exchange markets resulting in net purchases equal to 2% or more of GDP over the past year. China met two out of the three criteria (large trade surplus and current account surplus at over 3% of GDP) for enhanced analysis in Treasury’s April 2016 report. Treasury’s October 2016 report stated that China had met only one of the criteria (large trade surplus). So judging by U.S. criteria, the conclusion that China is a currency manipulator can’t be substantiated.

Third, treating the RMB exchange rate as the source of U.S. international transaction imbalance has no supporting proof. The U.S. trade deficit with China was $347 billion in 2016. Considering that the current statistics method cannot separate the export from the re-export (fake export), the deficit between China and U.S. is exaggerated. What’s more, the current account doesn’t give a complete picture of U.S. international transactions. It doesn’t include a large number of financial flows, which could be viewed as “adjustment items”. When we see the U.S.’s trade deficit with China, we shouldn’t forget U.S.’s financial surplus with China.

If the U.S. insisted on launching a trade war with China by imposing higher tariffs or labeling China as a currency manipulator, revoking former trade facilitation arrangements with China, that might reduce the direct bilateral deficit, but not the overall U.S. trade deficit. Protective barriers against Chinese imports would merely shift some of the bilateral trade deficit with other countries while raising prices for U.S. consumers.

Positively, we have observed that President Trump has changed his tone, compared to what he said in the presidential campaign. This is a sign of possible adjustment in the future. We also observe that there is a division between the White House and its executive branches. Obviously Trump’s technical officials are more rational and professional. We expect President Trump’s attitude on China to be more reasonable in the future.

Now the time window is still open. The candidates nominated by President Trump haven’t all finished their confirmation hearings. It’s said President Trump’s nominee confirmation process is the slowest in the past decades. As of now, there are still seven of 22 high level nominees waiting to be approved by the Senate. Though there are some opinions on U.S.-China economic and trade issues, there is not yet a unified official statement and policy. Both sides should make full use of the limited time window to have good and deep dialogue to find common grounds. Policy briefings, however, are not enough. Facing chaos and speculations, a formal summit between U.S. President Trump and China’s President Xi Jinping is both important and urgent.

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