The US Treasury’s Currency Report Backfire
The US Treasury Department’s twice yearly review of possible exchange rate manipulation singled out Asia and emerging markets China, India and Korea in particular, to alter investor perception into next year as other regions escape continued monitoring and punishment threats. The three quantitative criteria on trade and current account surpluses and intervention size were applied under 2015 revisions, and Japan was given a pass without explicit intervention, while Taiwan dropped from coverage altogether. India “shifted markedly” from 2017’s heavy currency purchases above the 2% of GDP threshold, but with rupee decline and an underlying current account deficit operations were only $4 billion through June, and it too could disappear in the next update if the bilateral trade surplus falls.
Korea has a 5% balance of payments surplus exceeding the 3% of GDP minimum, and the won has depreciated against the dollar this year although the International Monetary Fund still considers it undervalued. The central bank has been relatively quiet but does not disclose interventions, with greater transparency pledged in 2019. China analysis was the core theme amid rumors it could be again branded a manipulator after a 25-year hiatus. The report noted that despite Yuan slippage in recent months, the bilateral exchange rate in nominal terms was the same as a decade ago, amid “non-market” economic policy of stricter state control. The trading range between 6.8-6.9/dollar remains narrow and will swell future surpluses, and exchange rate practice is “disappointingly” hidden even if manipulation is no longer as plausible a finding as in past appreciation.
On capital flows net emerging market portfolio allocation outside China was negative $115 billion through mid-year, while stable foreign direct investment enabled “slightly positive” overall balance. In China outflows reversed, with stock and bond buying ahead of FDI for the period at $90 billion and $65 billion, respectively. Headline global reserves rose $40 billion to $11.5 trillion in the first half, with net accumulation despite higher dollar value adjustment. The Asian economies in focus have excess holdings beyond short-term debt and import needs. The IMF preaches against this tendency and instead urges “stronger policy frameworks,” according to the Treasury document.
It decries China’s “pervasive” subsidies and unfair trade behavior, while acknowledging “neutral” currency intervention estimated at $45 billion in the second quarter. Beijing may now be emphasizing administrative controls such as resuming the countercyclical factor in the daily fluctuation band, as it repeats the G-20 commitment to skirt competitive devaluation. Reserves are steady at $3.1 trillion with negligible capital exit outside the errors and omissions account, which indicates underground movement. The goods surplus will persist despite a services deficit even with GDP growth dipping to the 6.5% range until market forces and household consumption gain prominence, the US government warned.
At the IMF-World Bank gathering in Bali, Fund Managing Director Christine Lagarde rejected manipulation claims as China’s central bank head lauded a “reasonable equilibrium level” and analysts argued that a drop below 7/dollar was not a line in the sand. However during the meetings, international investors sold $150 billion under the Hong Kong Stock Connect, as the foreign exchange body SAFE revealed almost $5.5 trillion in total overseas liabilities. US Treasury Secretary Steven Mnuchin insisted that currency provisions would be part of any future trade understanding, following the model of the recent US-Mexico-Canada renegotiated agreement. Vice President Mike Pence set the stage in advance of the report with accusations of currency distortions and intellectual property “theft,” but bond managers largely shrugged off the rhetorical torrent in oversubscribing a $3 billion Chinese sovereign bond. They cited healthy central government figures in comparison with local authority off-balance sheet “titanic credit risks” of $5.75 trillion, according to rater Standard & Poor’s.
Korea is also in Treasury’s crosshairs as a currency clause was lacking in the revised bilateral free trade pact, and the IMF believes the won is currently 5% undervalued. It does not publish data on interventions presumably confined to “disorderly markets” from $400 billion in reserves, but promises to start next year. To reduce outsize external surpluses, the US called on Seoul to further stoke domestic demand despite onerous household debt. It welcomed the 2019 budget’s 10% spending increase, but the stock market is down by the same amount through September pending more decisive currency and credit cleanup.
