How Do Countries Manipulate Their Currencies? How Does it Impact Global Trade and Economy?
A celebrated Canadian businessman-turned-TV personality once said,
“Money is my military, each dollar a soldier”.
It’s remarkable how accurately that analogy holds in the current landscape of trade wars and currency wars under which each country is attempting to send their own currency into battle and take the other prisoner.
The United States has, time and again, blamed certain countries for holding its own currency hostage, namely: South Korea in 1988, Taiwan in 1988 and 1992 and China for as long as we can remember.
The latest entrants in the list are Switzerland and Vietnam, with India and Thailand receiving some collateral blame for devaluing their currencies against the dollar. How veritable is this currency-indictment and what effect does it have on the global economy?
Let’s find out!
What is Currency Manipulation?
It is the act of artificially lowering the value of one’s national currency with respect to foreign currency (typically the US dollar) using a range of policy measures by the government and the central bank. The intent behind doing so can be varied: promote exports, reduce imports, reduce debt interest burden etc.
A lower currency makes a country’s exports cheaper in the international market gaining an advantage in global trade. Once exports increase, so does the return on them which consequently narrows the trade deficit.
Even sovereign debt, the payments on which are denominated in the offshore currency, shrinks in value because a weaker domestic currency decreases the size of the debt.
How is it Different From Currency Regulation?
The difference is that manipulation is in line with prolonged foreign exchange intervention in one direction. Usually it is aimed at weakening the domestic currency or keeping it undervalued to gain trade advantage. It also affects the real exchange rate (inflation adjusted) and not the nominal rate.
Regulation, on the other hand, is devised through macroeconomic and monetary policy changes like monitoring interest rates, prices, quantitative easing etc., all of which all of which are designed primarily to stimulate domestic economic growth and with an additional intent of assisting export-led growth strategies. Even though they might be done with a protectionist agenda, they are not similar to manipulation because they have very attenuated and transitory effects of real exchange rates.
United States’ Grievance
Historically, ‘currency manipulation’ started as a nomenclature conferred by the US Government and allied authorities (Department of Treasury etc.) to countries that engage in what they believe are “unfair currency practices”.
In 2015, US Congress passed the Trade Enforcement Act which laid down the following three indicators to determine the culpability of countries with regards to currency manipulation:
- A $20bn+ trade surplus with the US
- A Current Account Surplus (CAS) of more than 2% of the country’s GDP
- Government purchases of dollars in the forex market of over 2% of the country’s GDP, with purchase of forex in six of the last twelve months
In 2019, China was branded as a currency manipulator by the Trump Administration, even though it didn’t qualify under some of the preceding indicators.
The Administration justified its actions by saying the determination was based on an earlier definition given under the 1988 Omnibus Foreign Trade and Competitiveness Act. This act has a much wider interpretation of the term bringing any action “preventing… balance of payments adjustments’’ into the definition of currency manipulation.
According to a few economists, instances of currency manipulation had relatively reduced since 2014. However, with current levels of appreciating dollar value, it is apparent why the authorities are apprehensive about the phenomenon again.
Why is the Dollar Prone to Manipulation?
At the Bretton Woods Conference in 1944, it was agreed that all central banks would maintain fixed exchange rates between their currencies and the US dollar. In return, the US will redeem dollars for gold on demand.
This meant that in place of gold reserves, other countries started stocking up on reserves of US dollars, making it the “global reserve currency”.
However, the downside to this unique title meant that investors are inclined to purchase it during uncertain economic times, because it is a “safe haven”. In fact this trade is popularly called “flight to quality”. For instance, when the drop in crude prices between 2014 and 2016 triggered a mini recession, investors thronged to the dollar, which ultimately increased its value by 25%.
Although in present times most of the currencies are free-floating, some countries peg their currencies to one another. China, for one, pegs its yuan to the dollar. So if China wishes to devalue the yuan, it simply has to adjust the peg, at the expense of the dollar, albeit.
The Case of Switzerland and Vietnam
The Swiss National Bank (SNB) has lately cultivated the practice of buying euros and then using it to buy other currencies. It does the same with dollar (as it did during the 2015 appreciation of the Swiss franc). While officials maintain that these interventions are to control the appreciation of an already overvalued Swiss franc, the volume of trade is enough to catch an eye.
The SNB has reportedly bought almost $20bn worth forex since June 2020.
Vietnam, on the other hand ran an intervention to push down the value of its currency for a trade advantage. The intervention also helped rush foreign investments into the country, subsequently, during the ongoing trade war between US and China. The high tariffs on Chinese goods had effectively helped Vietnam calibrate itself into China’s investment-savvy position.
Both Switzerland and Vietnam, consequently, have not only qualified, but far exceeded the criteria for currency manipulation under US law. Their forex interventions are estimated at 5% and 14% of the GDP, respectively (greater than the 2% threshold).
Is India Next On the List?
India was included in the currency watchlist in October 2018, but removed thereafter in May 2019. Now, it has been put back.
One reason as to why we are back is because of our burgeoning trade deficit ($22bn in the four quarters through June 2020) with the US. Net forex purchase also stands at $64bn (2.4% of GDP), thus triggering two out of three criteria for manipulation.
However, until now, the RBI’s currency intervention is largely viewed as “asymmetric” by US authorities which does not warrant inclusion in the list.
The Wall Street Journal once described how currency manipulation is so different from pornography, in the way that you don’t know it when you think you see it. It is hard to define and even harder to prove.
Assuming that is true, it is plausible to us all (including US authorities) that India’s currency devaluation strategy is more along the lines of regulation and not manipulation, yet.
(Originally published December 18th 2020 in transfin.in)
