Commentary | 09 February 2017

Will Trump declare a currency war?

The US president could find this weapon to be less effective than he thought, writes Stephen Grenville for the Nikkei Asian Review on 9 February.

The US president could find this weapon to be less effective than he thought, writes Stephen Grenville for the Nikkei Asian Review on 9 February.

US President Donald Trump has a simple criterion to judge whether America benefits from international trade: Is America exporting more than it is importing? He applies this criterion country by country. If the US has a bilateral current account deficit with a particular country, then it follows that this country is taking away jobs from Americans.

For some nations, such as Mexico, he threatens to respond by imposing a tariff. For others, he accuses them of manipulating their currencies. This opens up a new front in the still-simmering currency wars.

In 2010, Guido Mantega, then Brazilian finance minister, warned that a 'currency war' was underway. Europe, the US and the U.K. were attempting to boost their limp post-2008 recoveries through quantitative easing policies, which lowered interest rates and depreciated their currencies, he noted. This phase of the 'war' petered out quickly enough. Even when Japan's Abenomics in 2013 achieved a marked weakening of the yen through its mix of fiscal stimulus, monetary easing and structural reforms, the G7 countries were quick to defend these policies -- as well as Europe's active quantitative easing -- as legitimate monetary policy measures.

The lull since then in the currency wars has been broken by Trump's election. For him, world trade is like a business. If you want more profit, you have to sell more. If you do a deal, you want to squeeze and gain benefits in your favor, and you certainly do not want to give away more than you receive. Thus, it is not surprising that he sees the bilateral trade balance -- surplus or deficit -- as the best measure of a good or bad deal. To make America 'great again', as he has promised, the bad deals should be corrected. This puts the spotlight on Mexico, China, Germany and Japan, which all have substantial bilateral trade surpluses with the US.

Among these countries, the least culpable is China. Currency manipulation would have been an easy charge to level at Beijing a decade ago, when China was running a current account surplus close to 10% of gross domestic product and was building up foreign exchange reserves equal to 50% of GDP. It was intervening heavily in foreign exchange markets to stop the yuan from appreciating.

But that world has changed. The surplus is less than 3% of GDP. China no longer relies on international trade as its growth engine. The yuan has appreciated in inflation-adjusted terms by 30%, undermining China's international competitiveness, although more recently it has weakened again. True, there is still official intervention in China's foreign exchange market, but now the intention is to slow the yuan's depreciation.

Fred Bergsten of the Peterson Institute for International Economics in Washington has long accused China of being a 'currency manipulator,' but even he now accepts that this is no longer a valid charge.

China dilemma

This does not mean that China has moved out of Trump's sights. It still runs a huge bilateral surplus with the US of well over $300 billion each year, which is enough to keep it high up on the president's 'to-do-over' list. But it will be hard to make a charge of currency manipulation stick. If China lets its exchange rate float, the yuan would almost certainly depreciate, further improving China's international competitiveness.

Trump will have to find another way to deal with the Chinese. The rest of the world will watch this process with some trepidation, other less-subtle approaches such as generalized anti-dumping measures and demands for 'voluntary' export limitations might set off a trade war that would be potentially far more serious than a simple currency war.

Japan presents a trickier case as Trump prepares to meet Japanese Prime Minister Shinzo Abe in Washington on Feb. 10. Japan not only runs a bilateral surplus with the US of more than $60 billion, its overall current account is in persistent substantial surplus, at almost 3% of GDP right now. There can be little doubt that the introduction of Abenomics depreciated the yen exchange rate by 20% or so in late 2012 and early 2013, although the yen strengthened afterward.

The only question is whether this policy should be seen as a normal and legitimate monetary policy or as a form of currency manipulation by way of an abnormally expansionary monetary policy. It is true that Japan has not intervened in its currency markets in recent years, but negative interest rates and the strongest quantitative easing among major economies suggests that this is pushing monetary policy to the limits -- and arguably beyond. In addition, the main impact of Abenomics seems to be on the exchange rate, which is widely seen as a powerful advantage for the Japanese economy. At what stage does monetary policy become a beggar-thy-neighbor policy?

This question arose in 2012 when the US itself was undertaking active quantitative easing. The then chair of the US Federal Reserve, Ben Bernanke, defended quantitative easing as being in the global interest as the fall in interest rates stimulated the US economy, which in turn benefited everyone globally, he argued.

Whether this outweighed the exchange rate effect on foreigners was a moot point. But with a clear majority of the G-7 countries carrying out quantitative easing, they had no trouble is declaring this policy to be in the global interest. The rationale was that if all these countries were competing with each other to implement large quantitative easing simultaneously, this easy money environment would help the global economy.

Now, however, the US has a president who looks at global trade linkages deal-by-deal. He starts from the analytically irrelevant criterion of bilateral trade balances. He seems ready to impose import tariffs selectively against individual countries that that are judged harmful not only to the target country, but to the US as well. He has abandoned the Trans-Pacific Partnership free trade pact, which was a set of rules specifically designed to favor American companies. His main adviser on trade is Peter Navarro, the author of two books and related films, 'Death by China' and 'Crouching China,' that are stridently critical of China's trade policies and which are judged by many to be fringe views with little analytical substance.

Stronger dollar

The dangers here are compounded because other Trump policies, such as fiscal expansion, are likely to strengthen the dollar even further, increasing currency-based angst. And if Trump goes ahead with tariffs, that would also appreciate the dollar. We are likely to hear more thunder about currency wars in the year ahead.

Could a more sanguine view be justified? Compared with the uniquely complex multiple tasks of running a country, trade matters are perhaps closer to Trump's experience as a master of the 'Art of the Deal.' He may feel most comfortable flexing his muscles in this familiar territory as he settles into the wider task of the presidency.

We can only hope that bluster and bluff are just part of a bargaining strategy to achieve a self-serving but not totally irrational objective. After all, the best dealmakers know that you can push too hard.

There are some largely symbolic actions that could be taken. Declaring a country to be a currency manipulator does not in itself do much harm. When China is dumping its surplus manufacturing goods on international markets, a tough response by other countries is legitimate. Past trade deals such as the North American Free Trade Agreement can be renegotiated without killing their benefits. Skirmishes like this, with each declared to be a resounding victory, could give the new president the deal making satisfaction he seeks without putting world trade on the downward spiral of the 1930s.