As you may have heard, New York Senator Charles Schumer is on a campaign to slap a 27.5% tariff on all Chinese goods unless they significantly revalue or float the yuan. But he denies being a protectionist. No, you see he merely claims to be opposed to currency manipulation. His threat of tariffs are meant to force the Chinese to end their currency manipulation.
Had he been genuinely opposed to currency manipulation he would favor the abolition of the People’s Bank of China, the Federal Reserve and all other central banks. Any currency created by a central bank is bound to be manipulated. In fact, manipulating the currency is the task for which central banks were created for. If they didn’t manipulate the currency, there would be no reason to have a central bank.Needless to say, Senator Schumer, being a unrepentant statist, don’t favor the abolition of the Fed or call for the Chinese to do away with the People’s Bank of China. Instead he calls for the Chinese to do away with their peg to the dollar and float the yuan. According to Senator Schumer, currency pegs represent manipulation while currency floats doesn’t.
But how could it be argued that a floating fiat currency is not manipulated? First of all, the very existence of exchange rate fluctuations between different geographic areas is a manipulation as a free market monetary system -the gold standard- would not have such fluctuations based on national borders.
And moreover,while its price is settled on currency exchange markets, the price is heavily influenced by the central bank even in the absence of direct currency market interventions of the sort many Asian countries practiced in 2004. Through its direct control of short-term interest rates as well as the strong influence on money supply and long-term interest rates this imply, central banks strongly influence exchange rates and often use that influence in a mercantilist ways. This means that even if we narrow the definition of currency manipulation to manipulation of the currency for mercantilist purposes, floating currencies are certainly manipulated.
During 2005, interest rates have been a even more powerful tool than ever for central banks to influence exchange rates as exchange rate movements have shown a stronger correlation with interest rate movements and levels than ever before . The two big losers among currencies this year have been the Japanese yen and the Swedish krona, something which can be attributed to the zero interest rates in Japan and the interest rate cut from 2% to 1.5% in Sweden. The euro have risen against both the yen and the krona as its interest rates have risen slightly, but have fallen against the U.S. dollar where interest rates have gradually risen. The dollar in turn have fallen sharply against the Brazilian real as Brazil have kept short-term interest rates at double digit levels in both real and nominal terms. This development can largely be attributed to hedge funds increasingly engaging in so-called carry trade (interest rate arbitrage) by borrowing short in yen and kronor and investing them in American and Brazilian fixed-income securities.
Compare the cases of China and Japan. China can with some credibility claim that its peg was not instituted for mercantilist reasons as it did not take the opportunity that existed during the Asian crisis 1997-98 to devalue the yuan, despite the fact that it came under heavy pressure to do so.
Japan on the other hand must be judged more harshly in light of recent developments.
When the yen rose in 2004 because the markets were worried about the U.S. current account deficit it intervened heavily on the currency markets and bought large quantities of U.S. government bonds. This , they claimed, was not made for mercantilist reasons, but because they wanted to minimize the erratic exchange rate fluctuations that otherwise would have occurred.
During 2005 when the yen have fallen sharply against the dollar, with a dollar now costing 121 yen versus 103 yen in January, it have merely stopped buying U.S. government bonds. But had it really been sincere in its quest to avoid erratic exchange rate fluctuations, they should now not just not buy more U.S. bonds, but start selling those they previously accumulated. Yet this have not been done, and Japanese officials have in fact expressed satisfaction with the yen slide as they know it will benefit their exporters and help them combat the alleged scourge of deflation.
As we have seen with Japan, having a currency float is thus more effective if you wish to manipulate your currency for mercantilist reason. If China really wanted to nail Senator Schumer, they could just adopt Japanese strategy of having a currency float and then reduce interest rates and undertake other measures to encourage capital flight. Then the yuan would actually end up weaker than it is now, while Senator Schumer would be deprived of its argument for imposing tariffs.