The U.S.-China trade dispute gained some breathing room Sunday, when President Trump announced he would delay the threatened March 2 tariff increase, citing “substantial progress in our trade talks with China.” Just days earlier, however, the Trump administration had added a new wrinkle by putting another issue on the negotiating table: China’s exchange rate policy.
While Trump has been complaining about China’s currency manipulation since his time as a presidential candidate, this issue had largely been left out of the trade negotiations until now. Here’s what you need to know about Chinese currency policy — and why our research suggests this move is unlikely to secure significant policy concessions from Beijing.
The U.S. pushed China to adopt market-based exchange practices
The value of China’s currency, known as the renminbi (RMB) or yuan, is not set by market forces. Rather, China’s central bank largely sets the currency’s value. Historically, it has intervened in foreign exchange markets to keep the exchange rate artificially weak. A weaker renminbi makes Chinese exports cheaper on world markets — and makes it more expensive for consumers in China to buy imports. This policy has therefore contributed to China’s persistent trade surplus against the United States.
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The U.S. government has long pressured China to move toward a more flexible, market-based exchange rate, which would allow the renminbi to strengthen in value. This pressure may have yielded some success: China’s exchange rate grew more flexible and the renminbi strengthened in value between 2005 and 2014. Still, Beijing’s exchange rate reforms were probably driven as much domestic imperatives as by external ones.
The RMB has been falling against the dollar
But since March 2018, when the United States first imposed new tariffs on Chinese imports, the renminbi has lost about 6 percent of its value against the dollar. For Beijing, this currency depreciation helped blunt the impact of the U.S. tariffs.
If you’re a Chinese exporter, here’s how this works. A 6 percent depreciation in the renminbi is roughly analogous to reducing U.S. tariffs by 6 percent. This means that the current 10 percent tariff on Chinese imports only has the net effect of a 4 percent tariff, after accounting for the weaker renminbi. These realities are not lost on Beijing. In fact, last summer the Chinese government reportedly explored how depreciation might offset Trump’s policies.
Presumably, this is why the Trump administration decided to bring the issue of China’s currency back to the table. U.S. trade negotiators reportedly asked China to stabilize the value of the renminbi as part of the ongoing negotiations ahead of the March 2 date, when U.S. tariffs were slated to increase if the two sides could not reach a deal. From the U.S. perspective, the proposed March 2 tariff hike would do little to resolve the bilateral trade imbalance if China responded by weakening the renminbi.
Is this a significant change in U.S. policy?
One concern is that the latest U.S. request essentially reverses the long-standing U.S. position that China should move toward a free-floating currency. Eswar Prasad, a former head of the IMF’s China Division, called this shift away from pressuring China to adopt more market-based exchange rate policies a “worrying precedent.” Other economists called this a “loaded request” — the United States is asking China to give markets a greater role in its economy while also asking it to insulate the renminbi from market forces. For some observers, bundling these requests is an indication that Trump is “confused.”
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However, the impetus behind U.S. pressure was never really about getting China to adopt a more flexible exchange rate. U.S. advocacy for many years for China to adopt a market-determined exchange rate was simply about one goal: a stronger renminbi relative to the dollar. During past episodes of U.S. pressure on China’s currency, the renminbi was substantially undervalued, so the United States called for a flexible, market-based, exchange rate precisely because this would strengthen the renminbi.
By contrast, during periods when exchange rate flexibility would result in a weaker rather than stronger renminbi, the U.S. instead favored stability, not flexibility. For example, during the 1988 Asian financial crisis, President Bill Clinton “praised China” for keeping the exchange rate stable. Consistent with long-term U.S. goals, the current call for “stability” is really aimed at achieving one thing: a stronger renminbi.
How will China respond?
On Friday, reports emerged that China had agreed to the U.S. demand that it keep its exchange rate stable. Though details of the deal are scarce, Treasury Secretary Steven Mnuchin called this “one of the strongest agreements ever on currency.” Yet China’s promise to stabilize the currency follows years of statements from Beijing that it does not manipulate its currency for competitive purposes and wants to keep the renminbi “basically stable.”
Thus, a careful reading would suggest U.S. pressure has not delivered the policy change that the Trump administration is claiming. Nor is such pressure likely to yield meaningful change in the future.
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While U.S. pressure can nudge Chinese exchange rate policy in the desired direction in some circumstances, publicly pressuring China is often ineffective and can even backfire because it changes the political calculus for China’s leaders.
Our study with Dimitar Gueorguiev, forthcoming in the Journal of Conflict Resolution, reveals the risks in using public pressure. We surveyed roughly 2,000 Chinese citizens to ask their views about exchange rate policy. Some of our subjects were informed that the U.S. has been pressuring China to strengthen the renminbi, while others were not provided with this information.
Our data show that telling people that the U.S. wants China to appreciate its currency makes Chinese people more likely to think that appreciation will benefit the U.S. — and this, in turn, makes them less supportive of currency appreciation.
For this reason, public pressure might make it more difficult for Chinese leaders — who are often sensitive to public opinion and do not want to appear to be serving the interests of their geopolitical rival — to acquiesce to U.S. demands. The bottom line: U.S. pressure would be more likely to bring about significant change in China’s currency policy if the demand for stability remained private, rather than becoming publicized.
Daniel McDowell is an associate professor of political science at the Maxwell School at Syracuse University. Follow him on Twitter @daniel_mcdowell.
David A. Steinberg is an associate professor of international political economy at Johns Hopkins University’s School of Advanced International Studies and the author of “Demanding Devaluation” (Cornell University Press, 2015).