President Trump has finally found an economic issue that's not too complicated for him to do something about. That's stopping China from manipulating its currency that it hasn't been manipulating for the past two years.
Trump and Chinese premier Xi Jinping's met for the first time last week, following an election that featured more than the usual amount of China bashing. Indeed, ahead of the meeting, Trump himself promised that their tête-à-tête at Mar-a-Lago was going to be “very difficult” since we could “no longer have massive trade deficits and job losses” with them.
The only snag, as Trump's own Treasury Department could tell him, is that that trade deficit isn't the result of economic chicanery, but rather economic forces. China, you see, isn't holding its currency down anymore to subsidize its exports. In fact, it's doing the opposite: furiously spending down its at-one-point $4 trillion war chest of reserves to try to keep its currency from falling too fast.
But let's back up a minute. How does a country manipulate its currency, and why has China at least taken a break from it? Well, there's one big thing to keep in mind. It isn't enough to push your exchange rate down. You have to push your inflation rate down as well. That's because China's exporters wouldn't get much of a leg up on their foreign competition if their currency getting cheaper made their wages get more expensive. In other words, you can't just print money to make your money go down in value, but do so without letting inflation get out of control. And therein lies the rub.
Here's how to do it. Say you're a Chinese company that sells a lot to the United States. As lucrative as that might be, you're getting paid in dollars when you have to pay people yourself with yuan. Now, what would normally happen is you'd just turn those dollars into yuan. And as you, along with your other fellow big buyers of yuan, made that change, your combined demand would drive up the yuan's value. But from the government's perspective, that stronger currency is a problem, as it would put economically important (and politically connected) exporters in a weaker position in international markets.
So what actually happened is that Beijing stepped in. Beijing told businesses that it was the only one they could sell dollars to, and then printed the yuan to buy those dollars with. The idea being that all these freshly-minted yuan would be enough to counteract the upward pressure on the currency.
And that brings us to the second part. Now that it has created so many yuan, how does the Chinese government keep them from getting out into the economy and creating inflation? The question answers itself: it doesn't let them get out into the economy. It simply tells the banks — because where else are you going to put your yuan? — that they need to hold more money in reserve. And voilà, it's as if all the money that's been printed hasn't been. It just harmlessly sits in a bank vault where it can't push up prices or wages.
It's this combination of an artificially low currency and a legitimately low inflation rate that constituted manipulation. It let China make things cheaply and sell them even more cheaply so that they could gain as much market share as possible overseas. Which, of course, is just another way of saying that they unfairly undercut their competition, and, in the process, made it more attractive for multinationals to move their manufacturing plants from the Rust Belt to the Pearl River Delta.
But now that's over.
It's not that Chinese companies have stopped earning so many dollars. They haven't. It's that now they don't want to turn those dollars into yuan, and would rather keep them offshore. China's recent slowdown — that's what 6.6 percent growth is for them — has scared people into moving as much money as they can out of the country in case things get worse. It's a vicious circle where all this money leaving puts pressure on the yuan to weaken, which makes even more people rush to pull their money out before it loses any more value, and so on, and so on.
Beijing, for its part, has tried to put an end to this by manipulating its currency in reverse. Rather than printing yuan to buy dollars with, it has used its dollars to buy yuan. Perhaps you can see the problem, though. Whereas Beijing can print an unlimited supply of yuan to push its currency down, it has a limited, albeit large, supply of dollars with which to prop up its currency. That's why the government has made it harder to move money out in the first place — capping how much people are legally allowed to, and curbing how much companies can invest overseas — to try to keep how much it has to spend to a minimum. You would too if you'd dished out $1.2 trillion trying to keep your currency from falling, only to see it still drop 5 percent.
As for why Beijing is bothering to do this at all: It's partly because Chinese companies have run up so much dollar debt that they might not be able to pay it back if the yuan fell too much, but mostly because keeping the yuan stable was a prerequisite for it getting the IMF's imprimatur as a reserve currency.
One last point. Even though China is no longer holding the yuan down, and, according to the IMF, that currency is “no longer undervalued,” we still have a substantial trade deficit with the Chinese. That's a reminder that our trade balance is really the result of how much we save, and the exchange rate only matters to the extent that it affects that. Although Trump might be too busy doing his favorite thing — taking credit for what has already happened — to care much.
China isn't manipulating its currency, and all Trump had to do was nothing. Success!