Is Trump right to cry foul on FX manipulation?

“Germany…continues to exploit other countries in the EU as well as the US with an implicit Deutsche Mark that is grossly undervalued.”
Peter Navarro, head of the National Trade Council, Trump trade advisor, January 2017

“The euro exchange rate is, strictly speaking, too low for the German economy’s competitive position”
Wolfgang Schauble, German finance minister, February 2017 

President Trump and his advisors know how to provoke a reaction, and their recent accusations of currency manipulation have generated indignant responses from the so-called global elite. However, a sober assessment of the actual merits of these accusations show that there may be more to this issue than simple baiting and bombast on the part of an aggressive US administration.

The problem for both Trump and for those he accuses – specifically China, Japan and Germany – is that it is very hard to prove either foreign exchange (FX) market intervention, or the absence of intervention. Those who do intervene will rarely admit it – with some notable exceptions, like the Swiss National Bank (SNB) – and it is very hard to ‘prove’ intervention on an ex post basis using data alone.

However, there is one way in which we can try and get an indication, if not actual proof, of the extent to which a country is intervening in the FX markets, and that is to measure the growth in its foreign exchange reserves over time. Typically, an FX market intervention will involve the sale or purchase of foreign assets (currency) with domestic assets.

To weaken the Swiss franc (CHF), for instance, the SNB bought primarily euro assets with CHF. As such, a growing level of foreign exchange reserves of a given country or currency area may indicate intervention by its central bank; although it does not prove it, because foreign exchange reserves may change for reasons other than FX intervention, such as the payment of a foreign currency debt.

If we look at the FX reserves of those accused by Trump over the past decade, we can see that he may have a point:

Chart I: FX Reserves of China, Euro Area and Japan rebased, 2007 – present

Over the past decade China’s FX reserves have grown enormously – to the point where it is impossible to deny that the country has been intervening in the FX market. The case against Germany (the euro area) and Japan is a little less clear, but the fact that their FX reserves have also grown by about a third each is incriminating.  So far, so good for the Trump thesis.

However, if we look at what has been happening more recently, the results become a little less clear:

Chart II: FX Reserves of China, Euro Area and Japan rebased, 20012 – present

Since the 2008 global financial crisis, the FX reserves of both Japan and China have contracted. The eurozone, however, has seen material growth in its FX reserves over the same period. So far, based on the evidence of FX reserves alone, it appears that a strong case for FX manipulation exists against Germany and the Eurozone; a case bolstered by the fact that Germany recorded a trade surplus of nearly US$300bn in 2016, exceeding China’s by more than US$50bn.

Whilst the evidence available based on FX reserve accumulation does provide some prima facie evidence of FX intervention by all three central banks, it does not necessarily prove the case.  As mentioned, FX reserves can be accumulated for reasons that have nothing to do with the manipulation of the currency.

However, just as Trump had some ‘help’ from the previous Obama administration with the structure of his controversial travel ban – it was Obama who first implemented travel restrictions on the seven countries targeted by the Trump ban – the incoming president’s claims of currency manipulation are also supported, perhaps inadvertently, by his predecessor.

Under the Trade Enforcement Act of 2015, the Obama Treasury team came up with a list of the four criteria which determine whether a country may be defined as a ‘currency manipulator’:

  1. The country is a major trading partner (at least US$55bn of bilateral trade);
  2. The country runs a ‘significant’ trade surplus (more than US$20bn);
  3. The country has a ‘material’ current account surplus (more than 3% of gross domestic product (GDP)); and
  4. The country intervenes in a ‘persistent and one-sided’ way in the FX market (making FX purchases more than 2% of GDP).

Germany, China and Japan all meet at least three of the four criteria designed by Obama to identify currency manipulators. Whether that in itself should be considered enough to justify Trump’s accusation can be debated, but it is hard to argue that his position on this issue is without at least some merit.


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