Context: On 5/08/2019, the US Treasury Department declared that China is a currency manipulator. The move came after the People’s Bank of China (PBOC), the central bank of China, allowed the yuan to suddenly depreciate (or lose value) relative to the dollar by 1.9 per cent (one of the biggest single-day falls). As a result, the yuan breached the 7-to-a-dollar-mark for the first time since 2008. In retaliation, the US announced that it would approach the IMF “to eliminate the unfair competitive advantage created by China’s latest actions.”
What is a currency’s exchange rate?
- An exchange rate is the value of a nation's currency in terms of the currency of another nation or economic zone.
How are exchange rates determined?
- In an ideal world, the exchange rate for any currency would be determined by the interplay of its demand and supply. If more Indians want to buy US goods, there would be a higher demand for the dollar relative to the rupee.
- This, in turn, would mean the dollar would be “stronger” than the rupee — and gain in strength as the demand increases. If demand falls, the dollar would depreciate relative to the rupee (or the rupee would appreciate relative to the dollar).
What is currency manipulation?
- The real world is far from ideal. Most governments and central banks are bothered about generating more growth and employment at home. A weaker domestic currency comes in very handy when governments are trying to attract foreign demand and boost exports. China’s economic growth has been essentially fuelled by exporting to the world.
- Currency manipulation happens when governments try to artificially tweak the exchange rate to gain an “unfair” advantage in trade.
- In other words, if China’s central bank buys dollars in the forex market, it can artificially weaken the yuan and Chinese goods will then become more affordable (and competitive) in the international market.
Can currency manipulation be justified?
- Some amount of such “intervention” by central banks is allowed to reduce wild fluctuations in the exchange rate. But excessive and undisclosed interventions are not considered fair.