China, Manipulation, Day One, the 1988 Trade Act, and the Bennet Amendment

President-elect Trump has said that he plans to declare China a currency manipulator on day one.

I am among those who think this is a bad idea. This isn’t the right time to signal that China’s long-standing exchange rate management has crossed over the line and become manipulation. If China responded by ending all exchange rate management—no daily fix, no band, no intervention, a true float—the renminbi would certainly fall, and potentially fall by a lot.

Uncomfortable as it is to say, right now it is in the United States’ economic interest for China to continue to manage its exchange rate. Subsequent to the yuan’s August depreciation last summer, China has been selling large sums in the market—sums that increased in q3, after falling in q2—to control the yuan’s decline.

A freely floating yuan makes long-term architectural sense: the other SDR currencies float against each other, and China’s monetary policy shouldn’t be linked to that of the United States. But for China to be in a position where it can transition to a free float in a way that stabilizes the world economy, it needs both to do a serious recapitalization of its banks and to introduce a set of policy reforms that would strengthen the domestic base of China’s economy. Such reforms should include policies aimed at lowering China’s still exceptionally high level of savings.

That said, there currently seems to be a bit of confusion about what it takes for the Treasury to name China a manipulator, and what a designation of manipulation means.

My read of the Treasury’s April foreign exchange report is that this semi-annual currency report now satisfies two distinct statutory requirements.* The 1988 Omnibus Trade and Competitiveness Act (section 3004), and the 2015 Trade Facilitation and Trade Enforcement Act (and specifically the Bennet Amendment; Section 701).

The underlying requirements are similar, but not quite the same.

The 1988 Act empowers the Treasury to name a country as a manipulator:

“The Secretary of the Treasury shall analyze on an annual basis the exchange rate policies of foreign countries, in consultation with the International Monetary Fund, and consider whether countries manipulate the rate of exchange between their currency and the United States dollar for purposes of preventing effective balance of payments adjustments or gaining unfair competitive advantage in international trade.“ (emphasis added)

However, the 1988 act doesn’t authorize any specific sanctions that follow from naming a country a manipulator, only the initiation of negotiations with the named country. Manipulation is a label, nothing more. See Alan Beattie.

Of course, if there is a finding of manipulation and nothing changes after a year, Congress could pass a law authorizing some form of sanction, or one of the existing laws that the Peterson’s Gary Clyde Hufbauer has identified could be invoked, or link the finding to a new approach to safeguards, or (far less likely) the U.S. could file some kind of complaint at the WTO.

The Bennet amendment is different. It avoids the “manipulation” label. Rather it forces the Treasury to lay out specific numerical criteria for the bilateral trade balance, the current account and foreign exchange market intervention, and if those criteria are violated, it requires that a country be designated for “enhanced bilateral engagement.” If no solution is found after year of dialogue and negotiation, it requires that the President do one (or more) of four things: deny financing/risk insurance on new investment to the country through the Overseas Private Investment Corporation (OPIC); deny the country’s firms access to the U.S. government procurement market; seek additional IMF surveillance; and take into account the country’s currency practices in the negotiation of new trade agreements.

There is an escape clause as well.

The Treasury’s April 2016 foreign exchange report used the Bennet amendment’s criteria as the basis for its evaluation of the 1988 trade act. I lack a law degree, but I would bet that is a choice, not a legal requirement.

As I read it, a country that did not meet the criteria for enhanced bilateral engagement laid out in the Bennet amendment could still be named a manipulator under the 1988 trade law.

The Bennet sanctions wouldn’t automatically come into play. But several of those sanctions either aren’t particularly relevant for China, or could be replicated through other forms of executive action.

Set aside the specific thresholds the Treasury identified in April for the bilateral trade balance, the current account surplus, and intervention. No matter how the third criteria of the Bennet amendment is defined, China doesn’t meet it, at least not in any meaningful way.

I guess you could argue that that China’s reserves sale have been persistent and one-sided, and thus fit the letter of law. But China has sold foreign exchange in the market to keep the yuan from depreciating. The monthly data suggest has China not bought foreign exchange in the market to keep the yuan from appreciating in the past 6 quarters or so, only sold.** Its intervention in the market has worked to prevent exchange rate moves that would have the effect of widening China’s current account surplus over time. Every indicator of intervention that I track is telling the same story.

I can see how a case could be made that China’s broader exchange rate management—notably its use of the fix to guide the CNY—could meet the 1988 law’s definition of manipulation. The depreciation in the yuan’s daily fix (both against the dollar and the basket) has arguably impeded adjustment in the balance of payments and given China an advantage in trade, at least relative to a world where China had not changed its exchange rate regime last August. I have consistently argued that China’s currency is still tightly managed.***

But that doesn’t mean naming China is a good thing to do right now. Remember, if China stopped all management (“e.g. manipulation”) and let the yuan float against the dollar, China’s currency would drop. Possibly precipitously. China’s export machine would get a new boost. And rising exports would take pressure off China’s governments to make the difficult reforms needed to create a stronger domestic consumer base.

The goal of the United States right now, in my view, should be to encourage China to manage its currency in a way that doesn’t give rise to strong expectations of further depreciation that could fuel potentially unmanageable outflows—while encouraging China to put in place the bank recapitalization and social safety net needed to more permanently wean China off external demand.

Naming China as a manipulator doesn’t force a tit-for-tat escalation to a full trade war, at least not in the first instance.**** Subsequent actions of course could. But it also isn’t the most obvious way to convince China that it is in China’s interest to manage its currency—and more importantly its economy—in a way that reduces the risk of a large depreciation.

* pp. 6-7 of the April 2015 foreign exchange report suggests that the two acts differ: “Based on the analysis in this Report, Treasury has also concluded that no major trading partner of the United States met the standard of manipulating the rate of exchange between its currency and the United States dollar.” (emphasis added)

** The PBOC’s reserves haven’t shown any consistent increase -- using the PBOC’s yuan balance sheet -- since Q1 of 2014 (and April 2014). The small rise in October 2015 should be discounted given the magnitude of the sales in August and September, and the evidence from other indicators. The FX settlement data -- which includes the banks -- suggests very small purchases in q2 2015.

*** Technically, I think China could have reduced the scale of its reserve sales if it had managed the fix a bit differently; on occasion, it has had to intervene in the market to offset expectations of depreciation that the PBOC helped create through setting the fix at levels that suggested a desire for depreciation, whether against the dollar or against the basket. A small point. I have no doubt that the basic direction of pressure on the yuan/dollar changed after the dollar’s fall 2014 appreciation against a range of currencies.

**** Keith Bradsher is right to point out that both the U.S. and China would find it difficult to take trade actions that didn’t also hurt their own economies in important ways in the event of a major escalation. A large share of U.S. imports from China are consumer electronics where there isn’t any real option in the short-term to shift to domestic production, and a significant share of U.S. exports to China are commodities (ores, wood pulp, gold -- counting Hong Kong, soybeans, cotton, etc) where China would hurt itself by shutting out foreign supply/ raising the price of foreign supply (and in some cases the global market might adjust in ways that didn’t hurt the U.S. that much -- in soybeans for example an increase in Chinese purchases from Brazil would create opportunities for U.S. exports to markets now served by Brazil, just as Brazil’s bad harvest created an export opportunity for the U.S. in q3). The pain would go in both ways.