A couple of minor points about currency manipulation

Before I continue my series of posts about yuan-dollar manipulation, I want to deal with another couple of minor hydra-heads, which hopefully I can simply incapacitate without generating the usual multiplicative effect.

First is the use of the word “manipulation”. Some people would say that China is not “manipulating” its currency, just passively maintaining a peg to the dollar (or a slowly crawling peg to a basket of currencies that consists primarily of the dollar). This view might seem to cast doubt on the relevance of my assertion that “in a world without market failures, government intervention is always inefficient.” If China were maintaining its peg by means of monetary policy adjustments – the way such pegs are maintained in the textbook models – I would agree that this is not really a case of government intervention or manipulation.

But the reality is that China maintains its peg through direct intervention in the foreign exchange market while pursuing a monetary policy that often runs counter to its exchange rate objective. As a result, the People’s Bank of China accumulates large quantities of US Treasury notes and other US assets. Whether you want to call it “manipulation” is a semantic issue, but clearly the Chinese government is doing something that a purely passive government would not do: it is lending money. Depending on how you look at it, either the Chinese are following an active monetary policy that interferes with their passive exchange rate policy, or they are following an active exchange rate policy in spite of their sensible monetary policy. Either way, it constitutes government intervention. Though I recognize that other semantic conventions may be equally valid, I’ll continue to speak in terms of “currency manipulation”.

The second point is that the Chinese currency manipulation is partly just to compensate for another form of government intervention – capital controls. In other words, since China restricts its citizens from investing abroad, the government has to invest abroad to make up the difference. As I said in another post, a few economists think that, once China’s citizens fully realize their ability to invest abroad (beginning with the recent moves toward relaxation of capital controls), the government’s current currency policy will no longer require intervention. As I also said, those economists are a minority, and I am not one of them. Nonetheless it is important to keep in mind that not all of today’s yuan-dollar manipulation represents “net” government intervention.