President Trump labeled Chinese leaders as “the grand champions of currency manipulation” in his interview with Reuters on Feb 23, before the Department of Treasury comes to any conclusion. It represents his conviction that American job losses have been caused by trade deficit, especially with China, and that the latter is caused by an undervalued RMB, which in turn is “caused” by currency manipulation by the Chinese government.
If Donald Trump works in that direction and fights China, both China and the US will suffer, because all of the above three judgements are questionable.
No linkage found between US trade deficits and exchange rates
During the past eight years since the global financial crisis, no linkages have been found between the changes in US trade deficits and exchange rates.
In 2009, the US trade deficit with China fell drastically by $ 41.2 billion, to $ 226.88 billion. However, the RMB was pegged to the dollar that year. During the four years 2010-2013, the RMB appreciated by 12.0% over the dollar. The US trade deficit with China did not shrink. Instead, it expanded by 40.5%, to $ 318.68 billion in 2013. During 2014-2016, the RMB fell by an aggregate 12.1% to the dollar. However, it did not result in a US trade deficit rise. It remained strikingly steady at $ 347.04 billion in 2016, compared with $ 344.86 billion in 2014.
The US global trade deficit changes followed a similar pattern. In 2009, it fell drastically by $ 312.61 billion, to $ 503.58 billion. However, most of the fall was due to the sharp fall in global oil prices，although the dollar nominal index to major currencies fell by 9.4%. In the subsequent fours years of 2010-2013, the dollar index remained virtually unchanged — at 73.3033 in December 2009, 73.8001 in December 2010, 73.7907 in December 2011, 73.2222 in December 2012. The US global trade deficit, however, grew sharply by 45.1%, to $ 730.45 billion, only to fall marginally to $ US$ 689.47 billion in 2013 when, ironically, the dollar became stronger again, with its index rising to 76.1827 in December.
The period of 2014-2016 saw a much stronger dollar, with its index hitting 95.4259 in December 2016, or up 25.3%. America’s global trade deficit, on the other hand, remained surprisingly steady, at $ 735.46 in 2016, compared to $ 735.19 billion in 2014, a tiny rise of 0.03%!
No linkage found between changes in RMB and Chinese export performances
Facts since the financial crisis have not proven linkages between RMB exchanges rate changes and Chinese export performances. In 2009, Chinese exports fell sharply by 16.0%, to $ 1201.6 billion, with virtually no rate changes between RMB and the dollar, as RMB was pegged to the dollar. During 2010-2013, RMB rose by an aggregate 12.0% to the dollar from 6.8282 at the end of 2009 to 6.0969 at the end of 2013. The Chinese exports, instead of being discouraged, had strong growth during this period, with an aggregate growth of 83.9%, or 16.4% per annum! During the subsequent period of 2014-2016, the RMB fell by 12.1%. Nonetheless, it did not help Chinese export growth. On the contrary, Chinese exports fell by 10.5% in 2015-2016.
It shows that the Chinese export performance depends heavily on the world economic and market conditions. It grew strongly when the world market was stronger, even when the RMB rose against the dollar. When the world market conditions deteriorated, it performed badly, the fall of RMB against the dollar was no help. Hence, China does not need to manipulate its currency.
China has not manipulated its currency
The standard for the equilibrium exchange rate level of a currency is the real effective exchange rate (REER) by Bank of International Settlements. Based on 2010 as 100, the REER index of the dollar was 118.56 in January 2017, while that of the RMB was 123.44. The aggregate rise of the RMB was larger than the dollar over the past 6 years.
In 2013, the IMF found that RMB exchange rate was basically within the equilibrium range, based on the share of China’s CA surplus in GDP and that of its trade surplus in total trade volume in 2012. The REER of RMB in December 2012 was 109.94. It moved up by 12.3% to 123.44 in January 2017. Undoubtedly, RMB at current level is not undervalued.
The US criteria for currency manipulation are: First, the country in review has a trade surplus of over US$ 20 billion with the US. China has passed that threshold by far. Second, the country in review had a CA surplus equivalent to 3% of its GDP. China’s CA surplus in 2016 was 1.87% of its GDP. Thirdly, the monetary authority of the country in review had a net foreign exchange buying of over 2% of its GDP over the previous 12 months, to depress its currency. China’s central bank had a net foreign exchange selling of 3% of its GDP in 2016, to support RMB. Apparently, China has not manipulated its currency even by the US criteria.
US Trade Deficit Is Structural, Not Currency-Led
The US global trade balance pattern shows two opposite categories: the category of surpluses and that of deficits. In 2016, the category of surpluses includes agricultural products (US$ 32.67 billion), petroleum and coal products (US$ 26.78 billion), waste and scrap (US$ 12.20 billion), minerals (US$ 7.61 billion), paper (US$ 3.66 billion) and food manufactures (US$ 3.47 billion). The category of deficits includes computer and electronics (-US$ 170.81 billion), transportation equipment (-US$ 98.79 billion), oil & gas (-US$88.21 billion) and apparel (-US$ 79.52 billion). The two opposite categories share the same exchange rates. Apparently, the reason is not currency, but trade structure. It shows that the US agricultural products, minerals and other resources are mostly not in the global value chain (GVC) and enjoy comparative advantages. In energy supply, it depends heavily on imports. The size of trade deficit in this sector depends on world oil price levels. In other manufactures, the US has close division of labor with foreign countries, with technology development, design, branding and marketing mostly in the US, and processing and assembling largely in other countries. This pattern also explains why the US enjoys huge surplus in service trade but huge deficit in goods trade.
The US trade deficit with China is part of its global structural deficit. China accounted for 84% of its global trade deficit in computer and electronics, its largest deficit sector. However, it had trade surpluses with China in transportation equipment and oil & gas, its second the third largest global trade deficit sectors, due to the fact that China is the largest importer of the US aircrafts and is not the source for US oil & gas. In apparel trade, China accounted for only 38% of the US total global deficit, compared to 53% in 2013, showing a clear shift to its Asian neighbors as a base for apparel processing.
In 2016, the US had trade surpluses with China in agricultural products (US$ 16.61 billion, 50.8% of global total), transportation equipment (US$ 7.47 billion), waste and scrap (US$5.08 billion, 41.6% of global total), minerals (US$1.09billion, 14.3% of global total). Again, they shared the same currency conditions with the deficit products. It shows that, the US enjoys comparative advantages in agricultural products and minerals, not only globally, but also to China. In the GVC case, China differs from a major processing location (in computer and electronics) to a minor location (auto and parts), and even a minimal location (aircrafts).
In conclusion, the solution to reducing the US trade deficits, either globally or with China, lies in structural changes and cooperation in GVC, instead of entangling in exchange rates which will lead us to nowhere.