March 22, 2017

Mnuchin’s Mission by Jeffrey Frankel
A Brief Comment on China and US Currency Values

In an excellent note on Project Syndicate today entitled Mnuchin's Mission, Jeffrey Frankel wisely noted:
"Fortunately, Mnuchin has so far avoided fulfilling one of Trump’s irrational promises: to label China a currency manipulator on his first day in office. The next opportunity to take that step comes in April, when the biannual Treasury report to Congress is due. Mnuchin should let it pass."
We should be grateful to Professor Frankel for pointing out a truth that far too many people in Washington and in America refuse to accept:
China is NOT a currency manipulator today and has not been for at least the past two years. 

Even during the first decade of this century when China was probably engaged in currency manipulation as defined by the IMF, private cross-border flows purchasing dollars and dollar-based assets in US markets account for 80 percent of the net foreign purchase of US securities between 2000 and 2010. During the same period, official flows only accounted for 20 percent of the total (see chart). Of this 20 percent, only a small part might have been sanctioned as "currency manipulation." However, neither the IMF nor the US government found sufficient basis for doing so.

Hasn't the time come to point out, clearly and forcefully, that the dollar’s own overvaluation is a major factor driving America’s serious trade deficit?

America had deficits with over 100 countries in 2015. According to work done last year by Fred Bergsten (Time for Plaza II), the dollar in mid-2016 was 26.5% above its true trade-balancing equilibrium exchange rate, but the yuan was only 9.9% below the rate consistent with a zero balance. Given the dollar’s appreciation since mid-2016, the dollar may now be closer to 30% overvalued (see Federal Reserve data on the dollar's broad trade-weighted exchange rate index).

The pressures causing the dollar's overvaluation come largely from excessive foreign demand for dollars and dollar-based assets (see chart above). This pressure could be relieved by introducing a Market Access Charge (MAC). The MAC would be a small user charge on all foreign investors and speculators seeking to use America's capital markets when these markets are already so swamped with capital that the dollar is overvalued and trade deficits exceed one percent of GDP. For more details, see note on this blog describing how the MAC would help restore American manufacturing.

America Needs a Competitive Dollar - Now!

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