By Stephanie Segal —

On October 17, the Treasury Department released its semiannual report on Macroeconomic and Foreign Exchange Policies of Major Trading Partners of the United States. This report to Congress meets reporting and analysis obligations pursuant to Section 3004 of the Omnibus Trade and Competitiveness Act of 1988 (“the 1988 Act”) and Section 701 of the Trade Facilitation and Trade Enforcement Act of 2015 (“the 2015 Act”). Prior to its release, analysts had speculated Treasury might use the occasion to label China a currency manipulator, particularly in light of Treasury Secretary Mnuchin’s recent statement that he wants “to make sure China is not doing competitive devaluations.” There was also speculation that Treasury might expand the number of economies subject to monitoring in the report. While Treasury did neither this round, the report provides a harsh appraisal of China’s “economic model,” warns that it is following the renminbi’s (RMB) recent depreciation closely, and indicates it will be monitoring for “symmetrical” intervention, heightening U.S. rhetorical pressure on Beijing. In addition, the report’s discussion of International Economic Trends should not be ignored.

Q1: What’s new in this report?

A1: The biggest change from the April report is the addition of two pages in the Executive Summary dedicated to China. The summary gives a brief history of Chinese currency policy and concludes that China frequently intervened to keep the RMB significantly undervalued, “imposing significant and long-lasting hardship on American workers and companies.” The report expresses concern about RMB depreciation against the dollar since mid-June and argues that “China is not resisting depreciation through intervention as it had in the recent past.” It also steps-up calls for increased transparency from Beijing, noting deep disappointment that China “continues to refrain from disclosing its foreign exchange intervention.” This addition comes on the heels of South Korea’s commitment to begin publicly reporting foreign exchange intervention starting next year as well as the addition of binding transparency and reporting requirements on foreign exchange intervention in the United States-Mexico-Canada Agreement (USMCA), something Treasury Secretary Mnuchin says Washington wants to use in future trade deals.

Treasury also indicates that it will monitor whether trade partners’ intervention is “symmetrical”—that is, whether they intervene to mitigate depreciation to the same degree as they intervene to mitigate appreciation. This point of emphasis provides a new avenue to critique Chinese practices, and the same standard will likely be applied to other longtime surplus countries.

Q2: In light of Treasury’s assessment, why didn’t it name China a currency manipulator?

A2: Under the 2015 Act, Treasury evaluates the United States’ largest trading partners against three quantifiable criteria—a country’s goods trade balance with the United States; its current account surplus; and whether or not the country is “engaged in persistent one-sided intervention in the foreign exchange market”—to determine if a country is manipulating its currency. While China would have likely surpassed Treasury’s thresholds for all three criteria for every calendar year from 2004 to 2010, for the 12-month period used in the latest assessment (July 2017 to June 2018) only one criterion—the bilateral trade balance—is met.

The 1988 Act allows more flexibility, simply stipulating that Treasury “consider whether countries manipulate the rate of exchange between their currency and the dollar for purposes of preventing effective balance of payments adjustments or gaining unfair competitive advantage in international trade.” However, Treasury has indicated that making such a determination would require examining “a wider array of additional facts such as foreign exchange reserve coverage, capital controls, monetary policy, or inflation developments.” In the current environment, these considerations argue against labeling China a currency manipulator, as Beijing’s capital controls have been credited with supporting the currency by reducing private capital outflows, and any currency weakening from China’s more accommodative monetary policy could be justified as a necessary response to domestic economic deceleration.

Treasury’s analysis echoes the views of other economists. As IMF Managing Director Christine Lagarde and others have observed, the RMB’s decline is not remarkable in the context of the general depreciation of emerging market currencies against the dollar this year. In fact, in recent months, the People’s Bank of China is estimated to have sold foreign exchange reserves on net, propping up the value of the Chinese currency, and the report even acknowledges the link between RMB depreciation against the dollar and “U.S.-China trade-related risks.”

In addition, Treasury’s decision not to label China may reflect its aim to preserve the report’s credibility. The peculiar headline that preceded the report by more than a week, indicating that “Treasury staff has not labeled China as a currency manipulator,” would suggest an effort to preserve the technical basis for the assessment. Treasury and Secretary Mnuchin may also be attempting to set themselves apart from so-called China hawks in the administration. While the report’s focus and more assertive language toward China are unmistakable, it is accompanied by a commitment on the part of the United States to work “toward a fairer and more reciprocal trading relationship with China,” an outcome distinctly less gloomy than the 20-year Cold War some have predicted. The report also provides greater specificity relative to past reports as to what the United States wants from China: a reduction in “non-tariff barriers, widespread non-market mechanisms, the pervasive use of subsidies, and other unfair trading practices”—language that gets at the microeconomic as opposed to “macroeconomic and foreign exchange” drivers of trading outcomes.

Q3: Why didn’t Treasury expand the list of “Other Major Trading Partners,” and what are the takeaways for economies other than China?

A3: Some analysts have called for Treasury to expand the report’s coverage beyond the United States’ top 12 trading partners (plus Switzerland, which is included in the report and previously appeared on Treasury’s Monitoring List). Doing so could lead to emerging Asian economies like Thailand and Vietnam being designated, setting in motion a process of enhanced bilateral engagement and possibly punitive measures if corrective policies are not adopted. However, because Treasury has not designated any economy a currency manipulator since China in 1994, the stigma attached to whomever is next to receive the label will be significant; such a finding would definitely distract from what is clearly the administration’s current laser-like focus on China. That said, the idea of expanding the list has traction, and the right question is probably “when” and not “if” it will be expanded.

Regarding other economies on the Monitoring List, Treasury notes that India’s net purchases of foreign exchange have fallen sharply (a consequence of this year’s emerging market pressures) and says that if this continues, India will be taken off the Monitoring List following the April 2019 report. Consistent with its call for surplus countries to stimulate domestic demand to reduce trade imbalances, Treasury praises South Korea for proposing an expansionary budget and cautions Japan to offset revenues from its coming consumption tax hike enough to sustain its economic growth.

While not an explicit focus of the current report, Japan and Germany, two countries about to enter into trade negotiations with the United States (the latter as part of the European Union), should take note of the report’s discussion of International Economic Trends. Two graphs are particularly telling: The first is the IMF’s estimate of exchange rate misalignment, which clearly shows Germany as the economy with the greatest degree of real exchange rate undervaluation. The second is the chart of global current account balances, which highlights Germany and Japan as the two economies with the largest contributions to global current account surpluses. Economists like those who put together the report know that the current account—and not a bilateral trade balance—is the more accurate reflection of an economy’s impact on global demand.

Ms. Stephanie Segal is deputy director of and a senior fellow with the Simon Chair in Political Economy at CSIS. James Smyth, CSIS Simon Chair research intern, contributed to this CSIS Critical Questions piece, which first appeared here.