FX Manipulation: To Take Trump Seriously Means not Literally

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What should investors make of the fact that on the heels of a Treasury Dept report that did not conclude that any country was manipulating its currency, President Trump called China and Russia out for “currency devaluation games?”  Here are are some preliminary thoughts.

Through Republican and Democrat Administrations, no US president has found that a foreign country’s activities have risen to the level that can be considered manipulation for nearly a quarter of a century. Initially, the law required a judgment of intent. Intervention by itself, or even a pegged currency regime, was not proof of manipulation. Unsatisfied with the process, Congress provided some quantitative metrics, like a large bilateral surplus with the US, large external surplus overall, and significant intervention on one side of the market.

The Treasury issues its evaluation twice a year as Congress mandate. The latest report was released on April 13. Rhetoric and criticism of others by the administration aside, the Trump Administration found no country meets the three-fold criteria. There was little new in the report, except that India was added to the watchlist, and the Administration suggests that it may increase the number of countries that are included going forward.

On the very next business day, President Trump tweeted that China and Russia were playing a “currency devaluation game,” and that this was “not acceptable.” This is incongruous with the Treasury’s report and seemed to weigh on the dollar in the North American session.

It is confounding. The yuan has appreciated by around 10% over the past 12 months. As recently as last week, the new central bank governor announced that China would not weaponize the foreign exchange market. Contrary to the war camp, China indicated it will not devalue the yuan in the trade dispute with the US.

The ruble is a different story. It has tumbled around 9%, not so much because of Russia’s policies, but due to the increasing US sanctions against Russian companies and oligarchs, and the suggestion of more to come. US officials have increased the penalties for being on the wrong side of this one.

What is the US President signaling? The US Treasury report used a specific quantitative definition. Could Trump be saying that other metrics show China and Russia are purposely devaluing their currencies to secure trade advantage? He did not provide any evidence, and when reports pressed the Treasury Department, they were advised to contact the White House.  Later Secretary Mnuchin suggested the tweet was a warning.

A significant risk to investors is that for years, one was incentivized to take what a US President says literally. He is one of the most powerful men in the world by virtue of his position and is commander-in-chief of military might that is incomprehensible (e.g., the number of times its nuclear arsenal can destroy the world).

Yet investors and policymakers need to learn to take Trump seriously but not literally. Those who make a living parsing words suggest the US President undermined the Treasury’s report, as he had been critical of other cabinet officials, like Attorney General Sessions, or former Secretary of State Tillerson. Much ink was spilled, and many a column and blog post has been written about the administration’s latest contradiction.

To take Trump seriously means not taking him literally. What Trump is saying is that China and Russia are free-riders, taking advantage of the system. Combined with other tweets, Trump seems to believe that Putin has been duped to help countries like Syria, mistakenly (though Russia has been aiding Syria for decades, and maybe Putin is hard to fool). Trump suggests China takes advantage of the US because past US officials permitted it, and the US weak response encourages and sustains it.

US officials accept that capitalism and market economies create vast wealth. If currencies were allowed to truly float and goods and services were freely allowed to trade, there would be no sustained and large trade imbalances. To the extent, the US has a large and persistent current account deficit, they see signs of mischief and malpractice. The Trump Administration seems dedicated to trying to secure more of the fruits of the system to the US.

It has suggested it is willing to put at risk the entire system.  That system did not emerge after WWII like Athena popping out of Zeus’s head fully grown and armored. It has evolved in a clear direction over the past nearly three-quarters of a century. The willingness to jeopardize all of it will force some concessions as few are willing to take the same risk or call the US bluff.

During the Bretton Woods era, the US often called on Germany or Japan to re-value their currencies. One might be forgiven for seeing the similarities between a dollar devaluation and mark/yen appreciation. However, under the dollar-gold standards, there was an important difference. The dollar was pegged to gold, and the mark/yen (and nearly all the other currencies in the world) were pegged to the dollar.   The US was reluctant to change the dollar’s peg to gold, but it did want other countries to revalue against the dollar.

However, in the fiat era that we find ourselves, the difference is without significance.  Not only does Trump claim that China and Russia are gaming the rules, but he also may be revealing his preference for a weaker dollar.  Of course, of the myriad of factors that economists argue move the foreign exchange market, the wishes of policymakers tend not to be among the most salient.

Foreign exchange prices can be understood independent of the desire of officials, as the yen’s appreciation also amply demonstrates.  Still, knowing or strongly suspecting the US Administration may prefer a weaker dollar may give one a bias to hedge or reduce exposure, all else being equal.  It also underscores the current administration’s worldview.  Every country is trying to take advantage of the US, and the main objective is to prevent it.

The quantitative metric to determine currency manipulation was to be used for large countries or those with large imbalances.  The suggestion to include a wider range of countries may sound good in theory, but it requires greater resources and dilutes the effort by looking at countries whose bilateral surplus is hardly a rounding error for the US trade balance.

What goes unappreciated by homo economicus and trade warriors is that that the US deficit is a form of assistance that promotes development and economic stability for many small countries.  And remember trade is not even the main channel by which US companies service foreign demand.  For over half a century, the sales by affiliates of US multinationals outstrip US exports by more than four times.