Every now and then somebody gets charged with being a ‘currency manipulator’: one time it’s China, the next it’s the U.S. But it’s quite unjust to use the term ‘currency manipulator’ in the current global setting.
U.S.–China War That Just Isn’t There
China has long been accused of controlling the supply of renminibi to fix it at unfair rate and give exporters an advantage, right? No. This can never be true in the complete sense and the problem with people understanding it is the failure to grasp the basics of Balance of Payments.
China built its miracle on the foundation of exports and investment. Being a very stubborn exporter, it kept running huge trade surpluses for a long period of time. As an accounting measure, these trade surpluses had to be mirrored in the capital account by exporting the funds abroad with they got from trade. And while choosing to export them to U.S. by buying government securities did cap the renminbi’s exchange rate, it was not the only reason.
Furthermore, China over past few years has allowed some amount of appreciation, which can be seen in the Figure 1 below.
Figure 1: USD/CNY exchange rate
We could argue that the renminbis appreciation has been insufficient. But then, look who’s talking. Figure 2 displays WSJ Dollar Index (dollar weighted against 7 most traded currencies in the world), which shows the dollar clearly on a downward trajectory, effectively becoming cheaper.
Figure 2: USD against the world (as at August 9, 2013)
Source: DJ | FX Trader
The reason? An ever-expanding supply of dollars through endless QE and debt creation. So is China really the U.S.’ biggest economic enemy? It might be its own worst enemy. Those trade surpluses and accompanied capital account outflows meant it had to become a stubborn investor too, with more than half of its’ GDP being directed to investment. While investment is a welcome attribute, over-investment, as in China’s case, turned into unproductive investment and rising government debt to dangerous levels. So much for the gains from manipulating your currency.
What is relevant though is the importance of real factors. If we look at the real exchange rates, we find further evidence that China might very well be the wrong suspect – China’s real exchange rate has been appreciating, while U.S. dollar is marginally undervalued in real terms.
Figure 3: Real Effective Exchange Rate by BIS, 2010=100
Source: Haver, BIS
The same basic trend is displayed if we consider unit labor costs. They have been soaring in China, meaning that Chinese cost of production kept on climbing, curbing advantage for its exporters rather than increasing it. In other words, since the costs have been rising, the real price for Chinese goods have been on an upward trajectory, despite nominal exchange rate.
Figure 4: Unit Labor Costs, index 2005=100
On the other hand, the previous two figures suggest why it’s so hard to identify a true currency manipulator, as we have a mixed picture – according to REER and unit labor costs – the U.S. does not manipulate the dollar, despite its undervalued nominal currency, if we consult the WSJ Index.
Another interesting but underlooked fact is that China’s exports to US has been declining as a share of total exports (quite rapidly over the recent years!), thus it has been running out of reasons to actually manipulate renminbi against the dollar.
Figure 5: China’s exports to U.S. as a share of total exports
The Smooth Criminal
While Switzerland is branded a currency manipulator every now and then, that is definitely unfair. The Swiss National Bank has intervened in the FX market a number of times to fight the franc’s appreciation (or to keep it undervalued, if you will). In fact, it had adopted and official floor that it vowed franc will not breach.
As we can see from Figure 6, when the crisis hit, the Swiss franc enjoyed a safe-haven status and rapid appreciation followed.
Figure 6: EUR/CHF exchange rate
At first, interventions by the SNB did not have much of an effect, and it decided that more determination is needed. In 2011, it adopted a 1.20 floor.
To evaluate this determination we can look at the next picture, which compares FX reserves to GDP ratios of Switzerland and China.
Figure 7: FX reserves of GDP
Source: Haver, BIS
Not only the pace was faster in the SNB’s case, it also accumulated more reserves relative to GDP compared to the “biggest currency manipulator.” What makes Switzerland look more serious is the fact that its exports to the eurozone account for about 50% of total exports, while, as noted before, China proportion of exports to US as of share of the total is much smaller.
The question here is again: was it any use? It is doubtful. On one hand, we do have some real losses that Swiss exporters have experienced as a result of appreciating franc.
Figure 8: Effects of CHF appreciation
Source: Auer R., Saure P. CHF Strength and Swiss Export Performance – Evidence and Outlook From a Disaggregate Analysis
It is an old chart, but I find it illuminating. Exports were lower by around 40 billion CHF from Q4 2008 to Q1 2011 as a result of appreciation. However, at that time the SNB had already accumulated FX reserves totaling to about 40% of Switzerland’s GDP. But this is the case if we set benchmark exports at exchange rates of 2005, which is quite arbitrary. Thus, the losses (up to the given point) were not only small in absolute sense, but it was quite questionable.
Of course, without having further data on this point, one could argue that those losses might have continued to increase. But I consider it to be a weak argument, as when the global crisis bursts, conditions (exports in this case) changed irrevocably. The recent crisis will definitely have at least medium-term effects on economic structures around the globe. Thus, Switzerland’s actions to maintain its exchange rate might very well be buying time, instead of actually realizing the consequences of recent event.
And the price of it is truly dear. I leave the reader an easy exercise to find out how many billions SNB have truly lost as a result of its actions. Hint: it’s in double digits, and one could possibly form the idea from these two headlines – here and here.
Despite price advantages, Swiss exports seems to be on a downward trajectory:
Figure 9: Changes in SNB’s FX reserves and Swiss exports
There are few other cases to consider. The attentive reader would probably start wondering why the yen graph was left uncommented in Figure 3. You could argue that Japan could be considered as a suspect in currency manipulation – just look at the free fall!
But Japan is somewhat an outlier. While it’s true that since Shinzo Abe got into the prime minister chair, Japan’s currency has witnessed a sharp depreciation as a result of aggressive monetary policy. But this must be viewed in the context of the Lost Decade (if not two, seen in the picture below) that preceded it.
Figure 10: Japan’s GDP and export growth
However, despite almost free-falling currency, exports remained somewhat subdued, below pre-crisis levels (even if we zoom in into quarterly data).
There are few points to consider in this case. Abenomics can work if it wage growth follows correspondingly. So far, it reacted vaguely, thus the deprecation is actually hurting the average Japanese consumer, which despite growing (apparently) inflation will not pull the country out of stagnation. The upcoming sales tax hike might actually make things worse, though it’s needed to improve the fiscal prospects for the future. These on the other hand remain quite dim, as government debt standing above twice the size of GDP remains very sensitive to investors’ sentiment – if they start requiring higher yields, it might become unsustainable. And with that, cheaper currency will not be the way out.
Among those ‘left behind,’ we can also name Germany. Its perseverance to keep the eurozone together raised doubts about who is really benefiting: The PIIGS drowning in debt, or Germany itself, benefiting from cheaper currency. On one hand, the currency is cheaper in real terms. But does it make things fundamentally different?
Figure 11: Germany’s total exports and unit labor costs
Starting from 2010, total exports moved in tandem with labor costs. However, recently, the latter crossed with the former (as seen in the Figure 10) raising doubt about the sustainability of exports if we treat unit labor costs as a technical indicator.
This is a bit far-fetched, but we can see that once it rebounded to pre-crisis level, the growth slowed. We also have to account for the price Germany and its tax payers paid for keeping the eurozone together. Both the amount of euros devoted for this plan in absolute value and the level of electorate discontent raises doubt whether this was really as profitable as some claim.
I have tried to show that the crime of currency manipulation is not well-defined, as if we apply analysis of real variables, the conclusions depend too much upon arbitrary assumptions. It’s true that consequences of fiscal and monetary policies can and does move (or even distort) exchange rates for some time, but the question is whether these changes anything in a fundamental way. While a country can buy some time with a cheaper currency, in the end it will turn against it and the wasted time without structural reforms will be a factor weighing down its growth potential.