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Why currency manipulation rhetoric will grow louder

It is not just equities that are rebounding this month.

The dollar is up almost 2 per cent against a basket of its peers as it resumes an upward path that most in the foreign exchange market believe is the natural consequence of the economic policies Donald Trump has vowed to deliver.

Given the US president has suggested he prefers a weaker dollar, its fresh strength has left the market expecting the White House to ratchet up the accusations of currency manipulation against trading partners that were a big part of his campaign. As investors and traders ponder how big a role sparring over currency manipulation will have this year, here are some of the questions:

What is Trump’s accusation?
In simple terms: that countries have been weakening their currencies at the expense of US competitiveness and jobs. Mexico, Germany and Japan — significant trading partners of the US — have come under fire on the issue since Mr Trump took office. China, which accounted for almost half of America’s $763bn trade deficit in goods with the rest of the world in 2016, is seen by currency strategists as the president’s chief target. At the start of the month, he accused China and Japan of having “played the devaluation market, and we sit there like a bunch of dummies”. Switzerland, Taiwan and Korea were named in October on a currency watch list drawn up by the Obama administration.

Does the US have an official process for defining currency manipulators?
Yes. To be officially designated a manipulator, a country needs to have a “significant” trade surplus with the US, a current-account surplus that amounts to more than 3 per cent of its GDP and have persisted in “one-sided” intervention in the currency market. The US can then officially label a nation as a currency manipulator under the 1988 Trade and Competitiveness Act. This has happened in 1988 with Korea and Taiwan, in 1992 with Taiwan and China, and in 1994, with China once more.

Is there logic to the president’s accusations?
Certainly when it comes to US corporate profits, which a rising dollar does hurt.

Jane Foley, a currency strategist at Rabobank, says that on several measures of purchasing-power parity, the dollar looks overvalued against the euro and the yen. In valuation terms the president “does have a point”.

Yet by itself that does not substantiate Mr Trump’s allegations of manipulation. Germany cannot be accused of actively participating in a currency war, Ms Foley says, but its exporters do benefit from a euro that reflects not just the strength of the German economy but the weakness of other eurozone countries. As for China, it has been plundering its currency reserves in an effort to slow the fall in the renminbi, which has been under pressure from capital outflow.

What effect is Trump’s rhetoric having?
During the battle for the White House, Mr Trump frequently said he would declare China a manipulator on day one of his presidency. That hasn’t happened but the currencies of most of the countries that have or could be targets have risen so far this year. The yen is up 4 per cent, the euro and renminbi almost 2 per cent, the Taiwanese dollar more than 4 per cent, the Korean won more than 5 per cent and the Swiss franc 2 per cent.

Not all of this, though, can be put down to the noise around manipulation. While the dollar has strengthened this month, it weakened against a broad range of currencies in January as investors awaited more evidence of the reflationary policies that drove the greenback’s rally following his November election victory.

If manipulation is to have a more obvious effect in the currency universe, traders will need to see explicit action from the White House rather than jawboning.

“If he names them [as currency manipulators], my guess from the way the markets have reacted to other rhetoric is that there would be an initial knee-jerk reaction,” says Paul Lambert, head of currency at Insight Investments.

How have countries responded to the rhetoric?
Central banks such as the European Central Bank and the Bank of Japan have long insisted that their quantitative easing policies are not geared to achieving a weaker currency, even though that is the consequence. Indeed, the dollar weakened after the financial crisis as the Federal Reserve introduced monetary easing.

Jens Weidmann, president of the Bundesbank, responded this month to the attack by Peter Navarro, US trade adviser, on Germany for a “grossly undervalued” euro, arguing that the US had enjoyed a “very favourable competitive position for almost a decade”. Japan said its own easy policy was intended to boost inflation rather than weaken the yen and that it had not intervened in the currency markets since the 2011 earthquake and tsunami. And at their summit at Mr Trump’s Mar-a-Lago resort in Florida, the US president and Shinzo Abe, Japan’s prime minister, steered clear of the subject.

How might the issue develop?
If the White House named Korea or Taiwan as manipulators, says Jason Daw of Société Générale, “it would be negative for sentiment as the next concern would be what, if any, trade actions would be taken against them. And these concerns could be heightened due to the military importance of these countries in the region.”

Threats of action by the US against Switzerland could undermine its central bank that has long intervened in currency markets to weaken the franc, which has acted as a haven for investors during the economic crises of the past decade.

“The SNB needs international acceptance to continue foreign currency purchases. If the US Treasury were to label Switzerland a currency manipulator, the market would question whether its policy was sustainable — and its impact would be reduced,” says Maxime Botteron, economist at Credit Suisse.

The more difficult targets for the Trump administration are those that could hurt the US in a battle over protectionism and reprisals. If Mr Trump turns rhetoric into policy, that is where this issue is heading.

After all, says Mr Lambert of Insight Investments, if the accused countries were to give ground, “would that mean they could not have independent monetary policy? If you’re Japan and you want inflation to go up to 2 per cent, you wouldn’t be able to follow this policy.”

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