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Exchange Rates Currency Manipulation Eduqas Question
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Date : 09/10/2018
The US has recently accused a number of countries of keeping
their exchange rates below their free market level. The US has chosen three
criteria to use in order to help identify countries which may be using unfair
currency manipulation against the US. These criteria are that the country has: (1) a trade surplus
of larger than $20 billion. (2) a trade surplus
with the U.S. that is more than 3 percent of that country s own GDP. (3) engaged in Persistent one-sided intervention in
currency markets, defined as purchases of foreign currency amounting to more
than 2 percent of the country s GDP in a one-year period. Five countries (China, Japan, Korea, Taiwan and Germany)
currently meet two out of three of these criteria. Evaluate how likely it is that a
country meeting any two out of the three criteria above is manipulating its
currency unfairly. (20)An exchange rate is the price of one currency in terms of
another. In a free market the price of any currency is set by the interaction
of supply and demand. Some in the Trump administration argue that it is
currency manipulation, that is consistently buying dollars, which puts upward
pressure on the dollar making foreign goods cheap to buy leaving America with
enormous trade deficits and jobs being exported from America.A large trade surplus, for example $20 billion, should put
upward pressure on a country s exchange rate. For example, if Japan has a large
trade surplus with the US then this means that dollars are being sold to buy
yen with which to pay Japanese companies. However, trade is just one of the factors
that drives changes in exchange rates. Currency traders often see the dollar as
a safe haven during turbulent times and sell a variety of currencies to buy
dollars, thus pushing up the price of the dollar relative to other currencies.
The scale of these currency flows is so enormous, that they are very difficult
for any country, even with big foreign currency reserves, to manipulate
downwards.Foreign exchange rates are not just set by changes in visible
and invisible trade, but also buy movements on the Balance of Payments capital
account. People and institutions in the named countries may wish to buy assets
in the United States such as property, shares and Treasury Bills. In so doing,
they will sell their own currencies and buy dollars and other things being
equal push the demand curve for dollars outwards and thus pushing the dollar
exchange rate upwards. By running large fiscal deficits which need to be
financed it is very easy for the above countries to buy T Bills and put
downward pressure on their own currency vis a vis the US $. If the US regards
this as currency manipulation, then it could stop it by the US Federal Government
raising enough tax to pay for its spending. This would probably reduce private
consumption and therefore reduce the trade deficit.It is likely that foreign governments are aware that by
buying US assets such as Treasury Bills they are putting upward pressure on the
US dollar and as a result making it easier for their exporters to sell goods to
US consumers. The huge budget deficits and the dynamism of the US economy which
makes buying shares in many US companies attractive, means that people and
institutions in the named countries have every reason to buy dollars in order
to buy those assets. Hence, it very easy for the named countries to spend huge
sums, going towards 2 per cent of GDP, buying dollars on the foreign exchange
markets: the federal budget deficit gives them a good reason to do it. However, it is within the power of the US
government to raise taxation, and other things being equal, the deficit, which
reduces opportunities for foreign investors to buy T Bills and therefore the
need to buy dollars (the demand for dollars is derived), or raise interest
rates to discourage US private consumption and thus reduce the trade surpluses
of those countries with the US. It is likely that the trade surpluses are a
result of the named countries being net savers while the US is consumer of the
last resort The trade surpluses of the named countries may simply
reflect comparative advantage and the production strategies of trans-national
corporations. Apple chooses to use contractors in China to make its products because
of the low unit labour costs there. It would take a very sharp rise in the
value of the Chinese currency (Yuan) to cancel out the competitive advantage
that China has in this type of manufacturing.In conclusion, it is likely that the named countries may go
in for some currency manipulation, but the large size of the US federal budget
deficit invites the named countries to do that. The big trade surpluses do not necessarily
point to currency manipulation but to big imbalances in saving and consumption
between the US and some of its trading partners such as China. If the US put
its own fiscal house in order and did not borrow so much this would make it
much more difficult to manipulate its currency. Does the US want foreigners to
stop lending it money, so it is forced to hike interest rates, so Americans
save more?
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