Until not long ago, U.S. President Donald Trump was intent on waging a currency war with China. Now… he’s not.
What changed? Let me explain.
Donald Trump, October 22, 2016
Donald Trump, February 24, 2017
A month or so ago I killed a couple of hours on a rainy Sunday afternoon by taking my kids to see the new Batman Lego movie. As the movie finished, while the kids were rummaging around under their seats for misplaced/dropped shoes and water bottles, a familiar name in the closing film credits caught my eye – Executive Producer, Steven Mnuchin.
It’s not a common name, so I did a quick check on my phone – yes, this was the Steve Mnuchin, long-time friend of Donald Trump and the same Steve Mnuchin who, when he’s not producing movies about plastic objects coming to life to save the world, has a day job as U.S. Secretary of the Treasury.
As for the Lego movie, it was entertaining and I laughed out loud.
US-China currency war – who would win? Read: Three ways China wins under U.S. President Trump
I had exactly the same reaction this past Sunday morning over breakfast as I read through a recent report from Mnuchin’s Treasury Department.
The report was a summary of Foreign Exchange Policies of major U.S. trading partners. It’s a regular brief to Congress (the U.S. national legislative body) which reviews exchange rate policies from global U.S. trading partners. It provides an update on which countries are engaged in unfair practices or are outright manipulating their currencies.
The Treasury monitors three specific criteria that a trading partner must trigger to potentially incur further enforcement i.e. being “labelled” a currency manipulator.
The three criteria are:
- Running a significant trade surplus with the U.S. (that is, when a country exports a lot more to the U.S. than it imports).
- Running a material current account surplus being at least 3 percent of GDP. A current account surplus exists in countries that save more than they invest, and are a net lender to the rest of the world. Typically, these countries are large manufacturing exporters or energy exporters.
- Running persistent one-sided foreign exchange intervention – for example, consistently weakening a domestic currency by intervening in foreign exchange markets by selling (or printing) domestic currency and buying foreign currency. This intervention threshold is at least 2 percent of an economy’s GDP over a 12-month period.
If these three criteria are triggered by China, then the Treasury is mandated to spend a year trying to resolve the issue through negotiations with Chinese counterparts. And if those steps fail then there can be retaliatory measures such as stopping U.S. government development agencies from financing programs in China – although these have already been halted for years anyway after the 1989 Tiananmen square crackdown.
The “labelling” of China as a manipulator is more of a risk factor in its ability to further weaken Sino-U.S. relations through uncertainty – we don’t know how China would react. What would a war with China’s renminbi look like?
What we do know, or at least what we thought we knew, was Donald Trump’s view on the matter. He has consistently attacked China’s “devastating currency manipulation”.
Trump realizes a currency war with China is not a good idea
This is why Steve Mnuchin’s Treasury Report is so interesting. So what did the Lego movie master decide?
To save you the suspense, the Treasury Department gets straight to the point (on the first page in fact) and states the following:
Treasury has found in this Report that no major trading partner met all three criteria for the current reporting period. Similarly, based on the analysis in this Report, Treasury also concludes that no major trading partner of the United States met the standards identified in Section 3004 of the Omnibus Trade and Competitiveness Act of 1988 (the “1988 Act”) for currency manipulation in the second half of 2016.
So to be clear, Donald Trump’s Treasury Department has confirmed what we’ve been saying all along (below is an excerpt from January’s edition of The Churchouse Letter)
“It’s pretty hard to argue that China is guilty of anything here…
Pressure on the renminbi is not being engineered by the central bank. It is a by-product of an increasingly open Chinese capital account and the desire for individuals and companies to invest (or simply take money) offshore.
There is genuine demand for capital outflow which necessitates selling renminbi.
If anything, China is trying to stem capital outflow in a bid to soften the pace of depreciation!
Bear in mind, these capital outflows are both expected and long overdue. We wrote about this particular phenomenon nearly two years ago in ‘A $35 Trillion Dollar Bonanza’.”
But what I found so amusing in this report was the new additional language that Trump’s Treasury has now inserted. I immediately recognised the new text because I’d read the October 2016 report.
I’ve highlighted the significant additions in yellow below.
The first highlighted section complains that although the renminbi did appreciate against the dollar, China didn’t let its currency appreciate fast enough from its initial “deep undervaluation”. As a result (according to this line of argument), this caused significant and long-lasting hardship to American workers and companies. Sadly, however, the report doesn’t reference any supporting evidence of this hypothesis.
The second highlighted section finally acknowledges that China’s “recent intervention in foreign exchange markets has sought to prevent a rapid RMB depreciation that would have negative consequences for the United States…”.
So, according to the Treasury, first China damaged American workers and companies by not letting its currency appreciate fast enough… but now China is not only preventing depreciation, but that depreciation would also have “negative consequences for the United States”.
So now the U.S. is grateful China is intervening in its currency market because if it didn’t, the renminbi would depreciate faster!
It seems clear now why the Chinese haven’t taken this threat of labelling them as a “currency manipulator” terribly seriously.
But the Treasury saves the best ‘till last:
“China will need to demonstrate that its lack of intervention to resist appreciation over the last three years represents a durable policy shift by letting the RMB rise with market forces once appreciation pressures resume.”
“Lack of intervention to resist appreciation over the last three years”? There’s been no ‘appreciation’ pressure to resist!
See the chart below of the renminbi against the dollar over the past three years.
Go ahead, try and defuse that logic bomb.
China has spent the past three years fighting depreciation, not appreciation. The renminbi is down 14 percent against the dollar and it would be down a heck of a lot further had the People’s Bank of China (PBOC) not spent a trillion dollars in foreign currency reserves since early 2014 trying to defend it.
So, the first half of that sentence makes no sense.
But Trump’s renminbi capitulation comes in the second half where it says, “letting the RMB rise with market forces once appreciation pressures resume”.
This puts the entire “China currency manipulator” argument on ice for the foreseeable future. The Treasury has effectively just asked China to keep doing what they’re doing (that is, to resist further renminbi weakness), but to let the currency re-appreciate when the times comes. That could be five years away.
It’s hard to know what triggered this dramatic change of course by the Trump administration on the renminbi. The White House simply remarked that “circumstances change”, and Trump himself said, “Why would I call China a currency manipulator when they are working with us on the North Korean problem?”
Regardless of why the White House has completely backtracked on this issue, it does remove a potential negative overhang on Sino-U.S. relations.
It also affords us more certainty and stability with regard to our view on investing in China. Here’s one of the best ways to invest in China according to my colleague, Kim.