On August 5, 2019, the Trump Administration labeled China a "currency manipulator" after the US-China exchange rate fell below 7 RMB per 1 USD. This was the first time in more than a decade that the RMB had broken through this level, and it was viewed by President Trump as a direct response to his administration's decision to impose additional tariffs on imports from China under the ongoing Section 301 investigation into China's industrial practices.
In this alert, we review the legal, political, and economic implications of the US Treasury Department's decision to label China a currency manipulator. In short, while the direct legal implications of this move are limited, this decision sends a clear signal that a resolution of the US-China trade dispute is unlikely to be achieved soon, and that US businesses should prepare for more commercial disruption.
Legal Bases for Treasury's Decision
Two US statutes provide the US Department of the Treasury (Treasury) with the legal authority to designate a country as a currency manipulator. These two statutes – Section 3004 of the Omnibus Trade and Competitiveness Act of 1988 (1988 Act) and Section 701 of the 2015 Trade Facilitation and Trade Enforcement Act (2015 Act) – have similar but distinct standards and legal consequences. As a result, though the laws often work in concert, Treasury can determine that a country meets standards identified in one of the Acts without finding it to meet the standards identified in the other. We provide a brief overview of each Act below.
Section 3004 of the Omnibus Trade and Competitiveness Act of 1988 (1988 Act)
The 1988 Act directs Treasury to analyze "whether countries manipulate the rate of exchange between their currency and the United States dollar for purposes of preventing effective balance of payments adjustments or gaining unfair competitive advantage in international trade." This determination is subject to a broad range of factors, including trade and current account imbalances, foreign exchange intervention, and monetary policy.
If the Secretary of the Treasury (Secretary) considers that currency manipulation is occurring with respect to countries that (1) have material global current account surpluses; and (2) have significant bilateral trade surpluses with the United States, the Secretary must:
…take action to initiate negotiations with such foreign countries on an expedited basis, in the International Monetary Fund (IMF) or bilaterally, for the purpose of ensuring that such countries regularly and promptly adjust the rate of exchange between their currencies and the United States dollar to permit effective balance of payments adjustments and to eliminate the unfair advantage.
The Secretary is not required to initiate negotiations in cases where such negotiations would have a serious detrimental impact on vital national economic and security interests.
Section 701 of the 2015 Trade Facilitation and Trade Enforcement Act (2015 Act)
The 2015 Act requires Treasury to monitor the macroeconomic and currency policies of major trading partners and conduct enhanced analysis of and engagement with those partners if they trigger certain objective criteria which suggest the possibility of unfair currency practices. These criteria (and the metrics subsequently defined by Treasury) are:
- Significant bilateral trade surplus with the United States: at least $20 billion
- Material current account surplus: at least two percent of gross domestic product (GDP)
- Engaged in persistent one-sided intervention in the foreign exchange market: net purchases of foreign currency are conducted repeatedly, in at least 6 out of 12 months, and these net purchases total at least two percent of the economy's GDP over a 12-month period
If Treasury makes an affirmative determination of currency manipulation, Treasury is authorized to negotiate with that country in order to urge the country to adopt policies which address the causes of its currency’s undervaluation.
If after one year, Treasury determines that a "country has failed to adopt appropriate policies to correct the undervaluation and surpluses," the president must take one or more of the following actions:
- Prohibiting the Overseas Private Investment Corporation (OPIC) from approving new projects with the country
- Prohibiting the US federal government from procuring goods or services from the country
- Instructing the US Trade Representative (USTR) to take the currency manipulation into account in negotiating bilateral or regional trade agreements relating to the country
- Instructing the US Executive Director of the IMF to "call for additional rigorous surveillance of the macroeconomic and exchange rate policies of that country and, as appropriate, formal consultations on findings of currency manipulation."
The President can choose not to take remedial action where such action would have a serious detrimental impact on vital national economic and security interests.
In this respect, it is useful to recall that in its most recent semi-annual report to Congress, released May 2019, Treasury determined that China did not meet the standards to be deemed a currency manipulator identified in the 1988 Act or the 2015 Act. The report concluded that China had met only one of the criteria under the 2015 Act, namely, the maintenance of a "significant bilateral trade surplus with the United States, with this surplus accounting for a disproportionate share of the overall US trade deficit."
Legal Consequences of Designation
While the administration's decision to name China a currency manipulator resulted in substantial press coverage, the determination itself is unlikely to have any real, immediate legal consequences. It could, however, lead the administration to take action in other areas.
It appears that Treasury made its determination under the 1988 Act. As a result, Treasury is now authorized to initiate negotiations – either bilaterally or via the IMF – to address the US concerns.
The Treasury Department's August 5 press release announcing the designation stated that Secretary Mnuchin "will engage with the International Monetary Fund to eliminate the unfair competitive advantage created by China's latest actions." The prospects of this approach are limited, because it is not likely that the IMF will agree with the United States' conclusion that China is a currency manipulator. In its annual report reviewing China's economic policies, published four days after Treasury announced its designation, the IMF found that Beijing took steps to prop up the value of the yuan in the summer of 2018 and described the currency as "broadly stable" in the past year, depreciating only 2.5%. Other statements from IMF officials suggest that the IMF does not share the administration's view of China's monetary policy, and therefore, it is unlikely to help.
Bilateral negotiations are equally unlikely to succeed, as the US and China are already locked in talks on a number of difficult commercial issues where little progress is being made. Furthermore, it is difficult to imagine that China would agree to put the currency issue on the table as its view of the situation is entirely inconsistent with Treasury's.
Outside of the two remedial options listed in the 1988 Act, the Trump Administration could take action in two other areas:
First, Treasury could use its emergency Exchange Stabilization Fund (ESF) to buy yuan or sell dollars, counteracting the recent decrease in the value of the yuan without affecting the United States' money supply. This would likely be unpopular in Washington, as it could increase the cost of imports, and appear to jeopardize the dollar's important standing as the world's reserve currency. Though the US could use this tool in a symbolic retaliation, experts say the ESF's reserves are too small to significantly move foreign exchange markets. Its funds constitute most of the United States' $126 billion in reserves, but are insignificant relative to China's $3.1 trillion in reserves and the $5 trillion traded daily in the global currency market. While the Federal Reserve could have a greater impact – by printing US dollars and buying Chinese and other foreign currencies – it is legally independent, and is unlikely to adopt retaliatory, politicized measures against China in line with the administration’s agenda.
The second potential response relates to a proposed regulation released by the Department of Commerce (DOC) on May 28, 2019. The proposal advocated a change in the DOC's countervailing duty regulations which would allow it to treat artificial deflations of foreign currencies as countervailable subsidies. Under this proposal, the DOC would ask Treasury to rule on whether a given country was engaging in currency manipulation and if so, by how much. If Treasury agreed, the DOC would then be able to levy an additional tariff against the specific exporters under investigation to offset the benefit provided by the currency manipulation. While there was some initial skepticism that Treasury would ever respond affirmatively to the DOC's requests, now that Treasury has designated China as a currency manipulator, it may be more willing to entertain DOC's proposal, which increases the possibility that Chinese exports to the United States may face additional duties.
Practical Consequences of Designation, and Potential Impact on US Businesses
While the direct legal consequences of Treasury's designation are limited, it nevertheless has important symbolic ramifications. Notably, many commentators have expressed concern that it could signal the expansion of the US-China trade conflict into the realm of currency, prolonging and escalating the two countries' economic conflict to the detriment of a broad variety of businesses.
In the short term, the administration could cite the label as a justification for further tariff increases – most likely in the rate of duty applied, as opposed to covered products, as the great majority of Chinese imports have already been covered by Section 301 tariffs (assuming the most recently announced List 4A and 4B tariffs go into effect on September 1, 2019 and December 15, 2019, as planned). For example, the proposed tariff rate of 10% on these List 4 products could be increased to 25%, as was previously done for List 3, if the president concludes that China’s alleged currency manipulation is undermining the impact of these tariffs.
But the real impact is potentially more long term. After significant progress was made up through May 2019 to address the issues in the US-China relationship, those negotiations have now effectively broken down, with each side blaming the other for the impasse. And since that time, this administration has taken steps to make these negotiations ever more difficult – first by linking these negotiations with the steps taken against the Chinese electronics giant Huawei, and now by inserting currency manipulation into the mix. Both of these steps suggest that the chances that a solution can be found are getting dimmer.
For US businesses involved in or with China, this means that any hope for a quick fix of the current trade disputes needs to be put aside. It now seems increasingly unlikely that an agreement will be reached to lift the tariffs imposed by both parties. As a result, companies will need to devote even more attention to finding solutions for this situation which endure beyond the short-term.