Watch It, Mr Watch-Lister

The US has placed India on its watch-list of ‘currency manipulators’. This is a warning: economic sanctions may follow if the US determines that India is, indeed, a manipulator. There is no immediate danger. The US has three criteria for declaring a country a currency manipulator: a bilateral trade surplus with the US of over $20 billion; a current account surplus of over 3% of GDP; and net forex purchases of 2% of GDP within one year. India runs a big current account deficit of over 2.5% of GDP and, on that criterion, is well outside the danger zone of US sanctions.

However, the US definition of currency manipulation is economic bunkum. Bilateral trade deficits are completely irrelevant to currency manipulation. Worse, the US ignores other acts that artificially depress exchange rates. Why? Because the US itself is guilty of such manipulative acts, and pretends that these are just fine.

Stop Press! Actually, Don’t

Nothing is as certain to depress the exchange rate as massive money-printing. In what is politely called ‘quantitative easing’ (QE), the US Fed printed gargantuan sums unheard of in history to raise its holdings of securities from $0.8 trillion in 2008 to $4.5 trillion in 2017.

Money supply is only one of several factors determining the exchange rate, but it unquestionably matters. A big increase in money supply lowers interest rates, encouraging an outflow of money to other countries with higher rates. This will tend to depreciate the currency of the money-printer. Hence, big increases in money supply are a way of manipulating the exchange rate downward, helping one’s own exports.

Historically, the Fed set only shortterm interest rates by fiat, leaving bonds markets free to set long-term rates. But after the Great Recession of 2008, US Fed chief Ben Bernanke saw that even a short-term interest rate of zero was not enough to revive the economy. So, in three stages of QE, he pumped trillions of dollars into financial markets to purchase longterm securities, lowering long-term interest rates.

This did not cause a dollar collapse because other factors were at work. The Great Recession caused a panicky flight of global money into safe havens, and the US was the safest haven of all. Emerging markets and junk bonds were especially hard hit.QE prevented the dollar from rising much higher, and to that extent amounted to currency manipulation.

QE did not target the exchange rate. It aimed to raise overall demand. But that necessarily included raising export demand, via a cheaper currency. It was devaluation by other means.

Earlier, Japan in 2001 was the first to use QE. Finding that zero interest rates did not reverse a decade of stagnation, it began printing money massively to revive demand and fight deflation. One outcome was a cheaper yen. Japan’s aim was mainly to increase overall demand, but this also meant trying to depreciate the yen.

In the US, QE aided a very gradual economic revival, and was continued till September 2017. So, it was a currency manipulator for a clear nine years after 2008. QE exceeded 20% of GDP, yet the US calls a rise of 2% of GDP in other countries’ forex reserves evidence of manipulation.

The European Central Bank followed the US with its own QE. So did the Bank of England. Every western country printed enormous sums of money, and one well-understood consequence was the cheapening of their currencies. QE sparked the outflow of trillions of dollars into emerging markets in search of higher interest rates.

Exchange Rate? No, Keep It

Then, in 2013, the Fed hinted that QE might end soon. Financial markets were taken by surprise, and the impact on exchange rates was enormous. $1trillion flooded out of emerging markets, sending their exchange rates plunging. India’s exchange rate went from ₹55 to ₹68 to the dollar before stabilising at around ₹65.

Subsequently, the Fed has taken care to inform markets fully of coming rate changes. So, the end of QE has not created the panic seen in 2013. Still, that episode underscores the simple fact that manipulating money supply also means manipulating exchange rates. All Western countries have indulged in this.

US President Donald Trump has lambasted China for manipulation. Yet, interestingly, China is not on the latest US watch-list. In the 2000s, China ran up huge trade surpluses that would normally have appreciated the yuan. China avoided this by pulling dollars out of its financial markets to buy foreign securities, creating huge forex reserves of almost $4 trillion. That was a form of manipulation.

However, those days are gone. In 2016-17, China ran down almost $1trillion of foreign exchange reserves to check speculation, raising the yuan’s value. It is no longer manipulating its currency down.

The huge trade deficit of the US is a consequence of inadequate savings. It consumes more than it saves, and this means importing more than it exports. Instead of attending to its own shortcomings, it blames the outcome on manipulation by others. The truth is that its own manipulation, via QE, has proved insufficient to remedy its basic ills.

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