US says China manipulates yuan. What does that mean, how is it done?https://indianexpress.com/article/explained/us-says-china-manipulates-yuan-what-does-that-mean-how-is-it-done-5884193/

US says China manipulates yuan. What does that mean, how is it done?

Currency manipulation happens when governments try to artificially tweak the exchange rate to gain an “unfair” advantage in trade.

US President Donald Trump with China’s President Xi Jinping at the Great Hall of the People in Beijing, China. (Reuters/File)

On Monday, the US Treasury Department declared that China is a currency manipulator. The move came after the People’s Bank of China (PBOC), the central bank of China, allowed the yuan to suddenly depreciate (or lose value) relative to the dollar by 1.9 per cent — one of the biggest single-day falls. As a result, the yuan breached the 7-to-a-dollar-mark for the first time since 2008. In retaliation, the US announced that it would approach the International Monetary Fund “to eliminate the unfair competitive advantage created by China’s latest actions”. It signalled that the ongoing trade war between the world’s two biggest economies was now turning into a currency war as well.

What is a currency’s exchange rate?

In many ways, the exchange rate of your currency is the fundamental price in the economy. If an Indian car is worth Rs 10 lakh, then that is all the information we need to conduct that transaction; we do not have to wonder “what is the price of a rupee?”. However, if we’re trying to buy a car that was produced in, say the US, we would need more information than just its price (say, $15,000 in the US). This is because buying the imported car involves two transactions: one, using your rupees to buy 15,000 dollars; two, using these dollars to buy the car.

In the globalised world economy, where different parts of each good (and service) are produced in different countries, exchange rates become all important. It often determines the affordability of buying or selling internationally. So, if the rupee is at 70 to a dollar, the car may be affordable, but not so at 100 to a dollar.

How China is singling out the US Dollar

There is a flip side to this picture. While a stronger rupee (that is 70/$, instead of 100/$) is better for you as a consumer, it is worse for you if you were an Indian car manufacturer hoping to sell your car in the US. That’s because the rupee’s strength makes your car that much less affordable to US consumers.

How are exchange rates determined?

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In an ideal world, the exchange rate for any currency would be determined by the interplay of its demand and supply. If more Indians want to buy US goods, there would be a higher demand for the dollar relative to the rupee. This, in turn, would mean the dollar would be “stronger” than the rupee — and gain in strength as the demand increases. If demand falls, the dollar would depreciate relative to the rupee (or the rupee would appreciate relative to the dollar).

So, what is currency manipulation?

The real world is far from ideal. Most governments and central banks are bothered about generating more growth and employment at home. A weaker domestic currency comes in very handy when governments are trying to attract foreign demand and boost exports. China’s economic growth has been essentially fuelled by exporting to the world.

Currency manipulation happens when governments try to artificially tweak the exchange rate to gain an “unfair” advantage in trade. In other words, if China’s central bank buys dollars in the forex market, it can artificially weaken the yuan — and Chinese goods will then become more affordable (and competitive) in the international market.

Some amount of such “intervention” by central banks is allowed to reduce wild fluctuations in the exchange rate. But excessive and undisclosed interventions are not considered fair.

Consider: An American-made mobile phone could be in demand in India because it is a genuinely good phone. However, if a Chinese company can export a phone that is not only a close approximation of the American phone but also considerably “cheaper”, it is quite likely that the more price-sensitive Indian consumer will prefer the Chinese phone. Forget the Indians, if the Chinese phone is cheap enough, it might lure US consumers as well.

The key question is: what makes the Chinese phone cheaper? If it is the case that China is more efficient at making the phone, then nobody can complain. But if China is artificially reducing the “price” of its currency — by devaluing the yuan relative to the dollar or the rupee — it will be accused of manipulating its currency.

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How did the US conclude that China was manipulating the yuan?

In the so-called “FX report” released by the US Treasury Department in May, it found that the yuan’s depreciation against the dollar was far more than its depreciation against a trade-weighted basket of 24 currencies (see chart left). It also found that the yuan depreciated more than what it should have, if the fall were due only to the known interventions by the Chinese central bank. The US accused the People’s Bank of China of using China’s state-owned enterprises to do its dirty work. The US has also found that Chinese authorities intervene more assiduously when the yuan starts appreciating against the dollar, but look the other way when the yuan starts weakening.