The Oddities of Treasury's Official Currency Manipulator Watch List

This week, the US Treasury dropped its official designation of China as a currency manipulator … and added Switzerland to its watch list. China’s currency manipulator status lasted all of five months, and if you believe that China started manipulating the renminbi five months ago and has now magically stopped, we have a bridge to sell you. One that will take you straight to a beachside villa in Scottsdale. But funny as the China piece of this story is, considering Chinese authorities have mostly intervened to strengthen the yuan in recent years, the Swiss angle is even funnier. The direct implications here for investors are basically nil, but we do think the saga shows why the currency manipulator designation is mostly symbolic and not very meaningful for markets.

The US Treasury says a country is a currency manipulator if the following hold true. One, it heavily intervenes in currency markets. Two, it has a big trade surplus with the US. Three, it has a high current account surplus. The presumption is that if all three are true, the country must be artificially weakening its currency to gain an unfair advantage by making its exports cheaper (and imports more expensive).

We wrote last August why including China was dubious. The evidence overwhelmingly showed Chinese officials’ primary aim since 2015 was keeping the yuan stronger. As we explained (with charts): “Back in 2015, when the yuan weakened significantly (including a shock devaluation that August), the PBOC burned through about $1 trillion in foreign exchange reserves in an effort to defend the currency—or more simply, to keep it from weakening further. This time around, as the yuan weakened over the past 18 months, they didn’t burn through reserves, but they didn’t amass them either. If there were a deliberate effort to weaken the yuan, we would expect China’s forex reserves to jump.” We also noted that for several weeks in mid-2019, the yuan stayed suspiciously stable even as the dollar strengthened against a trade-weighted currency basket. If the yuan were trading freely, it would have weakened against the dollar alongside other currencies. Instead, it just hovered, another indication Chinese policymakers were trying to put a floor under it.

Now, Treasury officials know all this. They know how currency markets work and have access to the same data we do. But the currency manipulator designation is political, not economic. Its only real power is that it can serve as justification for tariffs. But the Trump administration was already using tariffs, justified on other means, before it officially labeled China a manipulator. Thus, we concluded slapping China with that label was just one more negotiating tactic, and a political stroke at that, in the trade tiff. The decision to remove it two days before phase one of the trade deal was signed Wednesday suggests our hunch was right.

But its inherently political nature isn’t the only reason this list isn’t hugely important. The currency manipulator watch list has long been a source of bizarritude—above and beyond saying a country that artificially strengthens its currency is trying to weaken it. Consider: Germany is on it. Even though Germany has not had its own national currency since 2002, when the last vestiges of the Deutsche mark faded into euros. Germany cannot be a currency manipulator, because it literally does not have a currency to manipulate. Neither do Italy and Ireland, which are also on the watch list. Switzerland does, however. It also has a central bank whose monetary policy has at times explicitly targeted an exchange rate floor with the euro. Policymakers officially capped the Swiss franc from September 2011 through January 2015. They removed the floor at that time but also began mirroring ECB policy, relying on negative interest rates to retain parity with the euro. Even then, the bank “reaffirmed its willingness to intervene in the foreign exchange market as necessary.”^[i]

In the last 40 years, Switzerland has put a floor under the franc’s exchange rate with only two currencies: the Deutsche mark and the euro. Perhaps we are oversimplifying the matter, but we don’t see how that would amount to seeking an unfair trade advantage with the US? Or even with Germany and the eurozone? Switzerland is a landlocked country that does most of its trade within Europe. A stable exchange rate is pretty key for Swiss exporters to be able to do things like budget. And plan. If the franc were swinging wildly, it would be quite hard to run a business. Stability also makes it easier for European countries trading into Switzerland. It is one less variable to have to account for.

Even if we set aside that logic, the Treasury’s move still seems odd. Why make the designation now? Why not 2011, 2012, 2013 or 2014, when actual currency manipulation was official central bank policy? Why not early 2018, when the franc was weaker versus the dollar than it is now? “Because trade deficit, silly!” is the obvious answer, but what about the fact America ran a small trade surplus with Switzerland in 2011, when the franc was at its nadir? Hey, maybe this is just the Trump administration’s way of trying to kick off trade talks! Stranger things have happened.

At any rate, we rather doubt this designation does anything. US trade with Ireland, Italy and Germany hasn’t suffered from their watch list inclusion. Being on the watch list doesn’t bring sanctions or tariffs—just boring write-ups in a Treasury report. So don’t get hung up on it—just have a good laugh at how arbitrary all of this is.