Chinese Currency Manipulation: Are There Any Solutions?

• Jurisdiction: United States,Federal
• Citation: Vol. 27 No. 2
• Publication year: 2013

Chinese Currency Manipulation: Are There Any Solutions?

Laurence Howard

CHINESE CURRENCY MANIPULATION: ARE THERE ANY SOLUTIONS?

Politicians often bellow about currency manipulation in an attempt to prove their toughness on foreign policy.¹ All too often these politicians seem under-informed about the subject.² In recent years, a substantial amount of political rhetoric in the United States has been aimed at addressing the "problem" of Chinese currency manipulation.³ Upon investigation, all of the proposed solutions prove inadequate, whether they call for greater cooperation with multi-national organizations, unilateral actions, or simple diplomacy.⁴

The majority of the discussion on this subject is based on the assumption that China is manipulating its currency, that this manipulation is a problem, and that the United States has a number of options available to address this problem.⁵ This Comment challenges all of those assumptions. First, whether or not China is manipulating its currency is debatable; additionally, many other countries are acting similarly, and this seems to be the norm rather than the exception. Second, the "problem" has less to do with China and the United States and more to do with general inefficiency in global trade. Third, even if Chinese currency manipulation is a problem, the current international framework is inadequate to handle it. Fourth, any bilateral or unilateral actions taken by the United States would either: 1) be ineffective or 2) cause more harm than good.

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This Comment proposes that there may not be any adequate solutions to the issue. If an adequate solution exists, it would likely come by means of a new global consensus and international convention, not by any existing mechanisms. Lastly, the problem with Chinese currency manipulation is not the devaluation of currency by China, but the regulatory regimes that enable it.

Part I of this Comment provides historical background, describing the history of exchange rate regulation and the current regulatory environment. Part II of the Comment describes the current currency manipulation by China in depth.⁶ Part III illustrates the inadequacies of the current avenues for multilateral solutions, including mechanisms provided by the World Trade Organization (WTO) and the International Monetary Fund (IMF), as well as other bilateral solutions. Part IV examines the different actions (or inaction) that the United States could take unilaterally. Part V discusses the benefits and feasibility of reaching an international consensus on the issue. Part VI proposes that this problem may actually correct itself in the medium or long term.

I. Background

A. Basics of Currency Manipulation

Currency manipulation occurs when a country artificially inflates or deflates its exchange rate.⁷ According to the Peterson Institute for International Economics (IIE), currency manipulation is "when a government buys or sells foreign currency to push the exchange rate of its currency away from its equilibrium value or to prevent the exchange rate from moving toward its equilibrium value."⁸ One way a country can devalue its currency is to print more money,⁹ and then use that new money to buy foreign debt and foreign currency.¹⁰ This increases the supply of the currency in the country printing

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money, which lowers the value of its currency. In turn, it decreases the supply of the target country's currency, which increases the value of its currency.¹¹

Countries may manipulate their currency for a number of reasons: to boost currency account surpluses,¹² for political gain,¹³ to avoid inflation,¹⁴ to make exports more competitive,¹⁵ or to reduce the inflow of capital into their country.¹⁶ Currency manipulation often causes many harmful effects,¹⁷ both to the domestic manufacturing industries of the non-manipulating countries and, on a larger scale, to the overall amount of world trade.¹⁸

Although research has been contradictory,¹⁹ a few commonly held assumptions exist concerning currency manipulation and its effect on trade. When a country's currency depreciates relative to other currencies, its exports become cheaper to importing countries, at least in the short term.²⁰ Conversely,

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it makes its imports relatively more expensive.²¹ When domestic goods are more expensive than the imports flooding in, domestic manufacturing suffers.²²

B. History of Currency Manipulation

The dangers of currency manipulation show prominently in the lessons learned from the 1920s and 1930s.²³ In fact, currency manipulation played an important role in ushering in the Great Depression, as nationalistic currency wars increased the rapid descent of an already weak global economy.²⁴ One after another, countries started to devalue their currency in an attempt to boost their exports and rescue their floundering economies.²⁵ This ignited a "race to the bottom," where one country's devaluation of their currency, an attempt to boost their exports in the short term, caused another country to respond in kind.²⁶ This competitive devaluation resulted in different manufacturing industries being ruined, as the market for imports and exports was effectively broken.²⁷

Countries believed that they had a sovereign right to value their currency however they decided to meet their economic agenda.²⁸ Countries then took corrective actions against undervalued imports to protect their domestic manufacturing, while at the same time propping up their own exports through the very process that prompted their own protectionist conduct.²⁹ Competitive devaluation led to rampant inflation, and the results proved to be disastrous.³⁰

Even while this competitive devaluation was occurring, at least a few researchers began to realize its negative effects. This emerging consciousness prompted the Federal Trade Commission (FTC) to examine the possible solutions to exchange rate manipulation.³¹ The FTC did not endorse any particular solution, simply noting that "[d]umping has been repeatedly recognized as unfair competition in national legislation and in international

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conferences and agreements, although it is sometimes very difficult to draw the line between what is fair and what is unfair in foreign-trade development."³² Even in the face of such research, an economic catastrophe like the Great Depression and World War II was necessary to induce reformation.

After World War II, the international community decided to prevent this madness—rampant inflation caused by competitive currency devaluation—from happening again.³³ At the 1944 Bretton Woods Conference, the major powers created the International Monetary Fund (IMF) and the World Bank.³⁴ Three years later, the General Agreement on Tariffs and Trade (GATT)³⁵ was finalized, indicating a shift from laissez faire economics to a regulatory regime designed to prevent the race to the bottom, which hastened the economic collapse of the Great Depression.³⁶ This was the first time that an international organization purported to regulate inter-state monetary affairs.³⁷ Prior to the formation of this regime, inter-state monetary affairs were either handled by bilateral agreements between countries, or not at all.³⁸

To achieve this goal, the IMF was charged with overseeing the international monetary system, which is "the system of exchange rates and international payments" that facilitates commerce between countries.³⁹ The IMF "ensure[s] exchange rate stability and encourage[s] its member countries to eliminate exchange restrictions that hinder[] trade."⁴⁰ Initially, the IMF pegged exchange rates to be measured by a standard par-value based on the value of gold.⁴¹ Members could change the par-value of their currency, but only to correct a fundamental disequilibrium.⁴² The IMF Articles of Agreement

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do not define fundamental disequilibrium, and the IMF has never defined a standard for it.⁴³

This system worked well, and the next three decades were prosperous.⁴⁴ Unfortunately, the stability of exchange rates would end in the late 1960s.⁴⁵ Countries began to desire more flexibility and sovereignty over their currencies, and by 1971, the gold standard system had completely fallen apart.⁴⁶ In 1971, the IMF's Board of Governors agreed on an amendment to the Articles of Agreement effectively recognizing that the gold standard system was no longer in force.⁴⁷ This amendment allowed IMF members to set their exchange rates as they saw proper.⁴⁸ Exchange-rate policies were still subject to IMF review and had to conform with the IMF Articles of Agreement, but stable exchange rates were no longer the standard.⁴⁹

When currencies are not pegged to a standard, problems arise. When two countries both exercise their sovereign right to set a bilateral exchange rate between their two currencies, they may arrive at two different values.⁵⁰ One country might say that their exchange rate is two to one, whereas another country might put it at three to one. Because of the incentive to manipulate these ratios, to boost exports or to increase current accounts, market distortions likely result. One particular instance where manipulation seems to be causing market distortion is in China, a problem that is discussed in the next section.

II. The "Problem"

A. China's Undervalued Currency

Politicians often decry currency manipulation in campaign speeches, congressional committee meetings, and debates to prove to constituents that they will be tough on countries trying to cheat the free market.⁵¹ The media has

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given particular prominence in recent years to China's currency manipulation, which began concurrently with China's admission to the WTO.⁵² At different times, China's currency, the renminbi (RMB),⁵³ has seen many different policy regimes; it has been pegged to the dollar, allowed to float, and intentionally devalued by the Chinese government.⁵⁴ Through all of that oscillation, the net result is that the Chinese currency has been, and...