The U.S. Treasury Department has recently made the official declaration that China is a currency manipulator. This announcement emerges in the wake of the People’s Bank of China (PBOC) permitting the yuan to devalue, or lose its comparative value against the dollar, by 1.9%. It represents one of the largest single-day declines in recent memory. This situation instigated as a response to newly imposed tariffs announced by the U.S. President on $300 billion of Chinese imports.
Consequences of Currency Manipulation
China’s sudden shift in its currency policy sent shockwaves through global markets, leading the S&P 500 Index to drop more than 1% in Asia. The S&P 500 or Standard & Poor’s 500 Index is a critical indicator of financial health as it is a market-capitalization-weighted index comprising the 500 largest U.S. publicly traded companies. A depreciation in the yuan renders Chinese exports more accessible and thus, more competitive in the global market, due to their relatively lower costs when purchased with foreign currencies. In response to this perceived unfair advantage, the U.S. government has pledged to engage with the International Monetary Fund (IMF) to rectify the imbalance created by China’s latest economic maneuverings. The ongoing trade war between two of the world’s largest economies is now poised on the brink of devolving into a full-blown currency war.
Understanding Currency Manipulation
Currency manipulation occurs when governments deliberately interfere with the exchange rate to secure unjust trade advantages. According to the US Treasury Department, a nation engages in currency manipulation when it intentionally affects the exchange rate between its currency and the US dollar to acquire an “unfair competitive advantage in international trade”. Upon being designated as a currency manipulator, the implicated country is expected to engage in negotiations with the U.S. However, authorities from Beijing and Washington have already been engaged in trade discussions for over a year.
| Country | Currency | Exchange Rate with USD (approx.) |
|---|---|---|
| China | Yuan | 6.38 |
| USA | Dollar | 1.00 |
The Implications of Exchange Rates
The exchange rate, which signifies the cost of one currency in relation to another, dictates the affordability of international buying or selling. For example, someone wanting to buy an American-made car would first have to exchange their native currency (rupees) for dollars before purchasing the car. The exchange rate fluctuates based on the demand and supply of a currency. If more people want to purchase US goods, the demand for the dollar will rise relative to the rupee, making the dollar “stronger”. As demand declines, the dollar would depreciate compared to the rupee (or the rupee would appreciate against the dollar). While the central bank of a country may intervene to dampen drastic fluctuations in the exchange rate, excessive and covert interventions are deemed unfair.
