MACROSCAN. Donald Trump’s exchange rate bogey

The past week was not a particularly successful one for President Donald Trump in the US, with the shambolic disarray evident in his attempt to remove and replace Obamacare with his own health Bill.

So perhaps it is not the most tactful time to point out that another of his pet peeves is equally likely to be exposed as based on shoddy reasoning. Even so, the truth will be out soon enough, so it may as well be stated now.

Throughout his Presidential campaign, and for much of his tenure in office thus far, Trump has railed against the supposed machinations of China, which he sees as responsible for sending cheap goods into the US by undervaluing the exchange rate, depriving US workers of jobs in manufacturing industry.

More recently, his trade advisor Peter Navarro has added Germany to the list of currency manipulators, using exchange rate changes to gain unfair competitive advantage over US producers.

The Trump administration has threatened all sorts of measures, including raising tariffs in response to this allegedly unfair trade practice. Indeed, the tax proposals championed by Republicans include border tax measures that would place higher tariffs across the board on all imports while allowing zero tax on exports, in the declared effort to bring production and therefore jobs back to the US.

Of course, it is not implausible that the tax plan could meet the same fate as the attempted revamp of the Affordable Care Act, especially since it is already evident that Republicans are also internally divided over many of its features.

Nevertheless, this accusation of currency manipulation, of perceived trade rivals using exchange rate changes to ensure their own trade surpluses, remains an important trope for the current US government. And it is taken as an article of faith by many Trump supporters as well. So it is worth examining the extent to which this quite widespread perception is borne out by facts.

On the face of it, the data on bilateral trade balances does seem to bear out Trump’s argument: both Germany and China have seen their trade surpluses with the US increase in recent years.

Chart 1 shows that Germany’s exports to the US from January 2010 increased until late 2014, although they appear to have tapered off and even declined slightly since then.

Since this occurred along with near stagnation in German’s imports from the US, the bilateral trade balance in favour of Germany improved, particularly from 2014 to early 2016.

The decline thereafter still leaves the German trade surplus with the US much higher in absolute terms than it was in early 2010, in fact nearly two and a half times as much.

Similarly, the Chinese trade surplus with the US has also increased since 2010. However, as Chart 2 indicates, Chinese exports to the US have shown a much more seasonal pattern, and therefore the trade balance also has shown a highly seasonal pattern.

Even so, it is evident that the bilateral trade surplus of China with the US has increased because Chinese exports to the US grew over this period even as the value of Chinese imports from the US barely increased.

If this pattern of increasing trade balances particularly between 2010 and 2015 were the result of currency manipulation, then the bilateral nominal exchange rates should have been moving towards greater depreciation of these currencies vis-à-vis the US dollar.

Chart 3 describes the movement of the Chinese currency, the renminbi (RMB), and the German currency, the euro, based on the values at the start of each month since January 2010. (In the chart, the scale is decreasing so an upward movement represents an appreciation and a downward movement indicate an appreciation.)

The results should come as a surprise at least to the Trump administration, or those of its members who swear by the idea of currency manipulation by these two countries. Between January 2010 and June 2014, the euro fluctuated around a largely stable trend, and appreciated quite substantially against the dollar.

So, clearly, the increase in Germany’s trade surplus with the US was despite its currency, not because of it! The US government will have to look for other culprits to explain the bilateral trade pattern, not the nominal exchange rate.

This is not to say that exchange rates are unimportant — they can and do play important roles, particularly when the real exchange rate shifts over a prolonged period.

But real exchange rates are not really a policy variable in the hands of a government; in fact, even nominal rates are increasingly hard to control, given the predominance of private capital flows in determining changes in currency markets.

In the case of Germany, the real exchange that has mattered most is paradoxically with other countries with who it shares the same currency, i.e. those in the Eurozone.

Germany’s ability and continued insistence to pass off productivity increases in the form of lower prices, rather than rewarding workers with higher wages, has created problems especially for other members of the Eurozone who are forced into ever greater deflation simply to try and reduce the imbalances this process creates. So the worst victims of Germany’s trade strategy are countries in the Eurozone periphery, not the US.

Similarly, Chart 3 shows that China’s currency appreciated continuously vis-à-vis the US dollar from early 2010 to around September 2015. This was precisely the period when the trade surplus with the US was increasing. Thereafter, there has been a rather precipitous depreciation of the RMB — but paradoxically, it is precisely in this period that the depreciating currency that Chinese exports to the US and its trade surplus have both stagnated.

Further, insofar as the Chinese authorities are intervening in the foreign exchange market at all, they are doing so in order to prevent further depreciation of the RMB, which has been driven by substantial capital outflows over the past year.

The imposition of various curbs on capital outflows and on currency trading are signs of this attempt to prevent further falls in the exchange rate.

So it seems as though, if President Trump chooses to pursue the line he has advocated with these two trading partners, he would be fighting yesterday’s battles, with little hope of relevance or even partial success in meeting declared goals.

Global trade patterns are volatile for sure, but they are being driven by factors more complex than the simple movement of nominal exchange rates.

COMMENT NOW