5 myths about currency manipulation and exchange rates

Most observers overestimate the importance of currency policy. This month, the International Monetary Fund (IMF) may name China’s yuan as one of its reserve currencies. Also this month, Congress could vote on whether to give Trade Promotion Authority (TPA) to President Obama. Then another vote looms on the Trans-Pacific Partnership (TPP).

{mosads}In these instances and others, currency manipulation will be treated as vital despite the fact that it is not particularly important to the United States. Dispelling myths about exchange rates makes this clearer.

Myth No. 1: An undervalued currency is a major economic advantage.

Fact: An undervalued currency makes imports more expensive and thus reduces the buying power of consumers, making the entire population worse off. If sustained, an undervalued currency causes production to tilt to exports rather than the home market, making jobs dependent on key global customers. Undervaluation is a high-risk choice.

The fortunes of the world’s major economies make this clear. The Indian rupee is undervalued, Indian wage costs are low, yet India is not competitive in global manufacturing. The European Central Bank has recently accepted a decline in the euro’s value against the dollar, but this cannot make a dent in the European Union’s problems. Japan has been accused of currency manipulation for decades, but personal income was the same in 2010 as it was in 1990.

Myth No. 2: Japan is a currency manipulator.

Fact: There is no definition by which Japan can still be called a currency manipulator, unless the U.S. is called one as well. It may be surprising to some that Japan ran merchandise trade deficits from 2011 to 2014. Last year, this deficit exceeded $100 billion.

In addition, Japan has not intervened in foreign exchange markets since the end of 2011, so it is not directly trying to change the value of the yen. The Bank of Japan has implemented very loose monetary policy, which can indirectly reduce the value of the yen. But the Federal Reserve has been doing the same thing.

Myth No. 3: China’s exchange rate policies cost American jobs.

Fact: History says otherwise. China devalued the yuan and was labeled a currency manipulator in 1994. American unemployment remained low and labor force participation very high for five years afterward, until the dotcom boom turned to bust. From 2005 to 2013, China slowly made the yuan more valuable against the dollar, as American protectionists demanded. Yet U.S. unemployment rose for most of the period and labor force participation declined throughout.

China steals huge amounts of intellectual property and large portions of its market are sealed off from American goods and services due to financial subsidies and limits on competition. These are far bigger problems than the value of the yuan.

Myth No. 4: The Chinese yuan is rising to challenge the dollar as the top global currency.

Fact: The yuan is not independent; it is a derivative or instrument of the dollar. It remains pegged to the dollar, rising against other currencies as the dollar rises and falling as the dollar falls. The yuan deviates from the dollar’s movements by only a few percent per year. If the IMF does add the yuan to its group of major currencies, it will actually increase the dollar’s importance by doing so.

The key steps in the yuan becoming an independent currency are to break the dollar peg and allow money to flow freely out of China. Beijing can do this at any time, but has for years lacked the nerve to leave the dollar’s protection and open China to financial competition.

Myth No. 5: Strong currency provisions are needed in the Trans-Pacific Partnership.

Fact: Our main TPP partners are not currency manipulators. American trade with Canada, Mexico and Japan was more than six times larger than with the rest of the TPP members combined, and none of the big three are manipulators. The crucial parts of the TPP are first opening the Japanese market, then improving trade within North America.

Even elsewhere, there are more important objectives. For example, Vietnam’s currency is so weak that pushing it 20 percent higher would just set the clock back to 2013. In contrast, forcing state-owned enterprises to compete fairly would revolutionize Vietnam’s economy. Currency is minor in the TPP, as well.

Scissors is a resident scholar at the American Enterprise Institute (AEI), where he studies Asian economic issues and trends.