China’s Currency Manipulation: Why It Isn’t A Threat To The Rest Of World

by The Indian Economist

— this post authored by Rodrigo Zeidan, NYU Shanghai

US President Donald Trump was right to accuse China of manipulating its currency –before changing his mind.

The same charge, however, could have been levelled from anywhere in the world.

Whether directly or indirectly, every country manipulates its money to a certain degree. Even among the one in three countries with floating currencies, about half consistently intervene to create stronger or weaker exchange rates.

The US has a floating currency, which means that the value of the dollar changes daily in response to the supply and demand for the greenback around the world.

But the central bank can affect the exchange rate as well, albeit indirectly. The US dollar rises and falls on pronouncements from the Federal Reserve about interest rates.

What really matters is not the manipulation but if it has deleterious effects on the rest of the world. Today, there are no such effects from China. Here is why.

Price control scheme

In a fixed exchange-rate regime (known as a peg), a country determines the price of its local currency and, as needed, buys or sells foreign currency to maintain that price.

This is analogous to any price-control scheme. If a gallon of gasoline cost US$1, for example, the government would have to supply extra fuel if demand increased. Conversely, if gas were US$5 per gallon, and fewer people than expected were buying, the government would have to pick up the slack.

Fixed rates require a country to correct any mismatch between supply and demand.

Source: IMF.

¹ Stabilised arrangements were added to the conventional peg classification.

² incorporates both crawling and crawling-like pegs.

When market agents stop believing that the government will step in to keep prices stable, then we have what is called a speculative attack. Domestic and foreign investors start to sell off a country’s currency assets.