"Russia and China are playing the currency devaluation game ... Not acceptable!" President Donald Trump's recent tweet encapsulates his fixation with bilateral trade balances and his economic ignorance. Bilateral trade deficits are anathema to him because he thinks they are caused by unfair manipulation of exchange rates to boost exports.
Every economist knows that bilateral balances are not a sensible macro-policy objective. But Trump gets some support for the notion of currency manipulation from U.S. Treasury economists, and from respected mainstream economists at the Peterson Institute for International Economics in Washington. Some clarification is needed.
Trump's focus on America's bilateral trade deficit with China has missed the fact that China has changed and can no longer be accused of intentionally keeping down the value of the yuan. Such manipulation may have occurred a decade ago, when China's surplus on the current account was equal to almost 10% of gross domestic product. The surplus is now less than 3% of GDP -- and in the meantime China has intervened to support its currency rather than to massage it down. Counting China as a currency manipulator is outdated.
The U.S. Congress requires the Treasury to report twice a year on the foreign exchange policies of America's major trading partners, evaluating them against three criteria: their current-account surpluses as a proportion of GDP; their interventions in foreign exchange markets; and their bilateral surpluses with the U.S.
None of America's major trading partners offends on all three criteria, but some have transgressed two of the three benchmarks and have been placed on a monitoring list. The most recent report highlighted China's bilateral surplus with America; Japan's continuing current account surplus (4% of GDP); South Korea's foreign exchange interventions and sustained current account surplus (5% of GDP); India's currency interventions (equal to more than 2% of GDP); Germany's current-account surplus (almost 10% of GDP); and Switzerland's interventions (6.6% of GDP) and current-account surplus (almost 10% of GDP).
Fred Bergsten and Joe Gagnon from the well-regarded Peterson Institute have waged a protracted campaign against what they call currency manipulation. Their long-time target was China, although they now accept that China is no longer a manipulator. Their criteria overlap with the Treasury's -- more comprehensive but excluding the economically nonsensical bilateral trade balance. Like the Treasury's monitoring list, Peterson's latest list is Asia-heavy: Hong Kong, Macau, Singapore, Taiwan and Thailand. Outside Asia there are three alleged manipulators: Switzerland, Israel and Norway. Germany escapes their ire by being a member of the euro area, without its own currency.
The concept of currency manipulation in the Peterson report reflects the strong free-market mindset of the institute's economists. But the focus on trade is too narrow, giving little role for capital flows, which often drive the current account. Some countries operate with sustained external deficits: Australia has done so for centuries, allowing investment in excess of domestic saving. By the same token, there are legitimate reasons for running an ongoing surplus. Resource exporters may want to accumulate foreign assets to cope with later resource depletion.
Likewise, favorable terms-of-trade provide an opportunity to accumulate foreign assets to prepare for harsher times. Changes in foreign sentiment, beyond domestic policy control, result in volatile capital flows. These surges and reversals of capital have encouraged countries -- especially those involved in the 1997-1998 Asian financial crisis -- to accumulate foreign reserves to smooth swings in their fragile exchange rates.
The International Monetary Fund, long a vocal opponent of foreign exchange intervention, has come to accept that it is sometimes sensible. Recognizing the volatility of capital flows, it now accepts the need for capital-flow management and currency intervention.
Nevertheless, there is a global consensus that external surpluses represent potential vulnerabilities to global growth because continuing deficits in other countries can cause debt sustainability problems. Correcting these imbalances is difficult because the pain is asymmetric: Deficit countries feel they are under threat while surplus countries have little motivation to help the adjustment process.
International action is needed to make the adjustment more symmetric. This was a central conundrum at the 1944 Bretton-Woods discussions, which led to the managed exchange rate regime that prevailed until 1971. For the past decade external imbalances have been a consistent theme of meetings of the Group of 20 leading economies.
The sort of scrutiny in the Treasury report and the Peterson analysis will not fade from the global policy discussion, especially when it coincides with presidential tweets and U.S. Congressional obsessions, no matter how ill-conceived these might be in terms of economics.
However, Japan may be able to avoid pressure, despite its large external surplus, if it continues to avoid currency intervention, as it has done for the past six years. Its zero level of official interest rates and well-established penchant for a depreciated yen will, however, keep it under scrutiny. South Korea might have more excuse for reserve accumulation after its experience in 2008, when it required substantial currency intervention by the Bank of Korea plus the resources of the U.S. Fed's currency swap lines to stabilize the won.
Singapore (with an external surplus close to 20% of GDP and official foreign assets which Peterson measures at 260% of GDP) has avoided censure only because it is small enough to escape attention. Thailand, with a current-account surplus of 10% of GDP and foreign reserves of 50% of GDP, might plead a defense in terms of its scars from the 1997 crisis. And all these Asian economies could point to Germany (which runs by far the largest external surplus in dollar terms) as a more blatant manipulator, with its export success hugely helped by an exchange rate which is held down by its less productive partner economies in the euro area.
This issue is more nuanced than either the Treasury report or the Peterson analysis admit, but the Asian countries on these lists should stand ready for further strongly worded presidential tweets, and, more substantively, to respond to rational global concerns about international imbalances.
Stephen Grenville is a nonresident fellow at the Lowy Institute in Sydney. He was deputy governor of the Reserve Bank of Australia.