The relative values of international currencies play a key role in global finance. Three areas that are particularly sensitive to exchange rate fluctuations are intercountry trade, pricing stability and regional economic growth.
In practice, governments and central banking authorities implement a collection of unique mechanisms to promote the stability of their domestic money. Central banks frequently employ devices such as interest rate adjustments, debt purchases and pegs to manage exchange rate volatility. Occasionally, controversial monetary policies such as quantitative easing (QE) are deemed to have artificially influenced currency values. In certain cases, the entities that promote such initiatives are classified as being currency manipulators.
Currency Manipulator Definition
Depending on the source, the exact meaning of the moniker "currency manipulator" varies. There are no concrete rules for determining who or what is a currency manipulator; in most instances, considerable judgment is involved in the process. Nonetheless, the United States Treasury Department spells out what a currency manipulator is in the Omnibus Trade and Competitiveness Act of 1988:
"Countries that manipulate the rate of exchange between their currency and the United States dollar for purposes of preventing effective balance of payments or gaining unfair competitive advantage in international trade."
The U.S. Treasury's outlook on the subject is specific to the United States dollar (USD) versus international currencies. However, it does share several commonly accepted principles included in a 2013 World Bank Group (WBG) working paper. In the paper, manipulation is referred to as "actions that cause an otherwise stationary price to move and enable the manipulator to take profit." Thus, from the perspective of an independent nation, a currency manipulator is any entity that influences exchange rates to profiteer via competitive advantage.
The issue of currency manipulation and who is engaging in the activity is debatable. Proponents of the manipulation narrative argue that many economies are adversely impacted by the monetary policies of other nations. Conversely, critics question whether or not it is possible to differentiate between legitimate policy and actual manipulation.
Advantages To Currency Devaluation
In relative terms, most countries favour a weaker domestic currency. While prolonged devaluations produce a collection of unique risks, sub-par valuations afford three primary advantages to the national economy:
1. Cheaper Exports
A weak domestic currency creates a price advantage over competitors abroad. Goods and services may be readily sold on international markets as the purchasing power of foreign consumers is enhanced. For instance, exports of U.S. automobiles typically fare well during downturns in the USD. This phenomenon has a tendency of positively affecting employment levels and gross domestic product (GDP) growth of the exporting nation.
2. Improved Trade Balance
Generally speaking, a robust export sector due to a devalued local currency fosters a positive trade balance. In other words, as international demand for exports increase and domestic demand for imports decrease, trade deficits typically reside. According to a 2013 study from the St. Louis Federal Reserve (FRED), the U.S. trade balance-to-trade ratio dropped from -6 to -16 during the period of 1995 to 2002. This period coincided with a 40% rally in the USD trade-weighted index, which suggested a negative correlation between exchange rates and the trade balance.
3. Lessened Sovereign Debt Obligations
Upon issuing foreign debt, a nation fulfills its debt obligations by making payments on outstanding balances. These payments are made in the foreign currency. Thus, a weaker domestic currency effectively dilutes debt repayment modules abroad.
The benefits of currency devaluation are cyclical in nature. The economic risks associated with a prolonged weak local currency can be severe. Several of the most devastating include extreme inflation, slower economic growth and compromised national creditworthiness.
Case Study: U.S./China Trade War of 2019
On 5 August 2019, the United States government labeled China a currency manipulator for the first time since 1994. The decision came on the heels of actions taken by the People's Bank of China (PBoC) that led to a 1.3% immediate crash in the Chinese yuan renminbi (CNY) versus the USD.
The sudden plunge in the CNY's value was one result of the PBoC setting its daily reference lending rate at 6.9 CNY to 1 USD. This value came in below the historical benchmark of 7.0, which led to public trade taking the USD/CNY to values not seen since 2008. Under pressure to respond to the surprise shift in policy, PBoC Governor Yi Gang issued the following statement:
"As a responsible big country, China will abide by the spirit of the G20 leaders' summit on the exchange rate issue, adhere to the market-determined exchange rate system, not engage in competitive devaluation, and not use the exchange rate for competitive purposes ..."
Although defended by the PBoC, the policy move was widely viewed as a response to a fresh set of U.S.-enacted export tariffs. U.S. President Donald Trump condemned the new PBoC policy publicly on Twitter:
"China dropped the price of their currency to an almost historic low. It's called "currency manipulation." Are you listening Federal Reserve? This is a major violation which will greatly weaken China over time!"
Shortly after Trump's tweet, U.S. Treasury Department Secretary Stephen Mnuchin officially labeled China a "currency manipulator." In a press release, the U.S. Treasury charged that China had violated its commitments to the G20 and did not "refrain from competitive devaluation." The grievance was then taken to the International Monetary Fund (IMF) for dispute resolution.
In an annual review of the Chinese economy, the IMF found little evidence of PBoC currency manipulation. Instead, the IMF cited that the CNY had been "broadly stable" throughout the previous year, depreciating only 2.5% against a basket of international currencies. In addition, the IMF stated that the CNY was "not significantly over or undervalued." Ultimately, the PBoC's decision to drop the overnight lending rate was attributed to market forces and the impact of extended tariffs on the Chinese economy.
The central theme of currency manipulation is straightforward: any entity that artificially influences exchange rate(s) for financial gain is deemed a manipulator. However, the reactions of China, the U.S. and IMF to the August 2019 devaluation of the CNY illustrates the role that perspective often plays in determining currency manipulation.
It is an economic truth that several advantages befall a nation that features a devalued domestic currency. A strong export sector, improved trade balance and reduced sovereign debt load are three of the primary economic benefits. Even though prolonged devaluation can have devastating consequences, many central banking authorities have historically favoured such measures. Nonetheless, in a majority of instances, differentiating legitimate policy decisions from malicious enterprise becomes a matter of interpretation.
Senior Market Specialist
Russell Shor (MSTA, CFTe, MFTA) is a Senior Market Specialist at FXCM. He joined the firm in October 2017 and has an Honours Degree in Economics from the University of South Africa and holds the coveted Certified Financial Technician and Master of Financial Technical Analysis qualifications from the International Federation…