The surprise announcement by the U.S. Treasury labeling China a “currency manipulator” raises a lot of questions. The answers to two of them in particular shed light on how trade tensions are likely to play out between the two largest economies in the world.
Is the label justified?
China does not currently fit the often-stated criteria for being a currency manipulator. While it still runs a trade surplus, its overall current position has not been in a persistent surplus. Its international reserves have declined in the last few years, as have its holdings of U.S. Treasuries. And to the extent that the authorities have influenced the exchange-rate-setting process – and they have – it’s been to slow the weakening of the currency rather than accentuate it. Indeed, if the Treasury Department labels China a currency manipulator based on recent actions, it should have done so years ago as well.
But viewing this issue in terms of a strict definition misses an important broader point. Both China and the U.S. have been weaponizing economic tools. The initial focus was on trade and foreign investment. It is now spreading to currencies. And all this reflects the extent to which the underlying drivers have extended well beyond economics to also involve national security and domestic politics.
From a U.S. government perspective, China has long sidestepped international norms regarding the protection of intellectual property and transfer of technology. It subsidizes its domestic firms, and its rapidly growing and extending tech companies are too closely integrated with the government. Add to that the view that China is increasingly aggressive in its relations with third countries (including via its Belt and Road Initiative for trade infrastructure and lending). The result is to fuel U.S. national security concerns, as well as unite domestic political alliances in the U.S., across party lines and involving both the public and private sectors.
The rationale for a more aggressive – or as some in Washington like to say “less accommodating” – approach toward China is accompanied by a timing issue: the “if not then when” hypothesis. With China embarked on a rapid and increasingly self-reinforcing development process that has also given it more systemic importance in the global economic and financial systems, the opportunities to level the playing field are viewed as increasingly few and fleeting.
The concern in Beijing is that the U.S. is out to “contain” China, which presents the government there with delicate trade-offs in how it reacts to what it has labeled U.S. bullying and provocations. This may also explain why the central bank’s rather aggressive verbal response – saying the U.S. decision “seriously harms international rules” – was not accompanied by immediate aggressive actions. Instead, the central bank set the midpoint of the currency below 7 per US dollar, and in a manner that helped both the onshore and offshore appreciate on Tuesday.
So what will be the impact of the Treasury designation?
In its press release, the Treasury Department noted that “as a result of this determination, Secretary Mnuchin will engage with the International Monetary Fund to eliminate the unfair competitive advantage created by China’s latest actions.” But the IMF found no evidence of currency manipulation when it last looked into the matter a few months ago. The real impact may not come through the IMF, especially as some other surplus countries run policy stances that are inconsistent with quick and orderly global adjustment.
But the labeling could open China up to an additional series of actions from both the U.S. public and private sectors. It could also be used by the U.S. government to pressure close allies to take a more aggressive stance against what they also view as legitimate grievances against China – especially as it pertains to intellectual property rights and the forced transfer of technology. It’s also not out of the question that this could be supplemented down the road by more directive pressures by the U.S.
Both the motivation and the likely consequences suggest that Monday’s announcement is yet another notable step in an escalation of tensions between China and the U.S. that could well get worse before it gets better. They suggest that, for those looking for calmer times in international trade relations, the best that could be realistically hoped for is a series of ceasefires. The more likely outcome for the coming months, if not longer, is intensifying trade tensions coupled with intensifying currency tensions.
Mohamed A. El-Erian is a Bloomberg Opinion columnist. He is the chief economic adviser at Allianz SE, the parent company of Pimco, where he served as CEO and co-CIO. He is president-elect of Queens' College, Cambridge, senior adviser at Gramercy and professor of practice at Wharton. His books include 'The Only Game in Town' and 'When Markets Collide.'
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