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BOHANON & STYRING: Both sides have it wrong on currency manipulation

March 4, 2017

Economic AnalysisIn current political parlance, “currency manipulation” ranks as an outright international economic crime. The so-called manipulation of foreign currencies relative to the dollar is alleged to cause most of our economic ills. The Trump administration is known for its anti-manipulation rhetoric, but so are Bernie Sanders and other Democrats. Complaining about this is a bipartisan sport.

Of course, central banks, including our own Federal Reserve, intervene in currency markets. The Fed used its heft to persuade central bankers in Europe, England and China to coordinate monetary policy during the 2008 financial crisis. Wasn’t that currency manipulation? Well, sure, but that is not what the critics are talking about. 

The “crime” of currency manipulation is the persistent intervention by a foreign nation’s central bank in the currency market with the objective of driving and keeping down the value of its currency relative to the dollar. An undervalued foreign currency means an overvalued dollar. Many nations have been accused of this, but the usual suspect is China.

How does China do it? Simple. The Central Bank of the Republic of China has the power to create an unlimited amount of its own currency: the yuan. So it buys a lot of dollars when creating new yuan. Supply and demand tells us the price of the dollar will rise relative to the yuan, from say, six yuan per dollar to seven yuan to the dollar. Americans will find it takes fewer dollars to buy Chinese goods. Correspondingly, the Chinese find it takes more yuan to buy our goods. We buy more from China. China buys less from us. That creates a bigger U.S. trade deficit. Let’s set aside for now the question of whether this is such a terrible thing and assume it is. Are the Chinese guilty of currency manipulation?

Well, no. At least not in the last few years. The Bank of China has been intervening in the foreign exchange markets, but it has been selling its U.S. dollar reserves. You read that correctly. Selling its dollars to prop up its yuan. This is exactly the opposite of what our leaders claim. In the last couple of years, the Bank of China has sold at least $300 billion trying to keep the yuan from falling.

We’re no fans of mercantilist Chinese economic policies. But let’s not accuse the Chinese of currency manipulation when it isn’t happening. Making policy on incorrect premises never leads to good outcomes.•

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Bohanon is a professor of economics at Ball State University. Styring is an economist and independent researcher. Both also blog at INforefront.com. Send comments to ibjedit@ibj.com.

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