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Former US Federal Reserve chair Janet Yellen says central banks need to be able to use all policy levers, including exchange rates, to meet domestic economic needs. Photo: Reuters

US must be ‘careful’ in demanding stable Chinese yuan to end trade war, says former US central bank head

  • Former US Federal Reserve chair Janet Yellen said it is ‘difficult and treacherous’ to define when a country is manipulating its currency
  • Donald Trump’s administration have alleged China has been manipulating the currency in a bid to offset increased tariffs

Former US Federal Reserve chair Janet Yellen – refuting the Trump administration’s allegations that China is a currency manipulator – wants American trade negotiators to think twice about asking China to maintain a stable exchange rate between the yuan and the US dollar, as it is “difficult and treacherous” to define when a country is manipulating its currency.

Central banks need to be able to use all policy levers, including the exchange rate, to meet domestic economic needs, Yellen told a Brookings Institution podcast, warning the US trade negotiation team “not to define policy tools as currency manipulation”.

The US has insisted that China keep the yuan exchange rate stable as a condition for ending the trade war, to prevent it from using devaluation to offset the effects of American trade tariffs, Bloomberg reported this week.

That call was in harmony with Washington’s long-time insistence that China adopt a market-oriented exchange rate system so that the yuan can find its “fair value” against the US dollar.

The US and the other industrial nations that make up the G7 have for years defined currency manipulation as directly intervening in the foreign exchange market to alter a currency’s value to improve a country’s international competitive position and trade flows.

But Yellen said countries should be allowed to use key macroeconomic policy levers, including the exchange rate, to achieve domestic policy goals regarding price stability and full employment.

“Monetary policy does have a systematic effect on a country’s exchange rate but, nevertheless, I think that it’s widely agreed that it should be available to be used for domestic purposes,” the former Fed chief said.

“So we would want to be careful not to define domestic policy tools as currency manipulation.”

Some tools that central banks used to help stabilise their economies inevitably weakened their currencies, she said.

China’s central bank said new yuan loans almost tripled in January. Photo: Reuters

A Reuters report on Thursday that the US and China had started to draw up six memorandums of understanding to cover trade issues, including currency policy, raised expectations that China would agree to maintain a stable yuan, and sent the yuan traded in China to its strongest level in seven months.

The yuan pared its gains to trade at 6.6879 on Friday.

ING Bank Greater China economist Iris Pang said the “unwritten understanding of any agreement” in the memorandums of understanding could be for the People’s Bank of China (PBOC) to keep the yuan at “south of seven” to the US dollar.

Such an agreement would prevent China “from devaluing its way out of a sharp narrowing in its trade balance”, she said in an interview.

The yuan fell by as much as 8 per cent against the dollar last year, raising US Treasury suspicions that the drop was not entirely market-led, Pang said.

Watch: Donald Trump's reversal: Beijing is not a currency manipulator (April 2017)

Lu Ting, chief China economist at Nomura, said that a “stable” yuan-dollar exchange rate could result in an increasingly overvalued yuan, which would slow Chinese export growth and increase the country’s account deficit.

As exports weakened from an overvalued currency, China could be forced to further loosen its monetary policy to stimulate the economy, pushing asset price bubbles to unsustainable levels, he said.

China should learn from Japan’s mistakes in the late 1980s and early 1990s, when it allowed an asset price bubble consisting of greatly inflated property and stock market prices to burst, causing its economy to stagnate, Lu said.

“Given the sharp divergence between gross domestic product growth rates, inflation rates, monetary policies and other socioeconomic characteristics, the best exchange rate policy for both China and the US is to further de-peg the yuan from the dollar and encourage Beijing to further reform its exchange rate regime towards a free-floating one,” he said.

On Thursday, Chinese Premier Li Keqiang highlighted a concern over the impact of Beijing’s recent monetary easing measures, warning of the “new potential risks” created by a record level of new loans in January.

Credit easing could trigger a resurgence in speculative financial activity that would not benefit the real economy and could potentially put the financial system at risk, he said.

The PBOC said new yuan loans in January almost tripled from the previous month to 3.23 trillion yuan (US$480.8 billion), or 5.5 per cent higher than the 3.06 trillion yuan reported in January 2018.

However, in its quarterly report published on Thursday, the central bank said it did not have a lot of room to manoeuvre on policy.

According to research firm Trivium China, the PBOC will not launch a major monetary stimulus this year.

“China’s central bank said it considers the country’s interest rates to be at a relatively low level amid rising financing costs abroad, pushing back against market expectations of an imminent cut in benchmark rates,” it said.


This article appeared in the South China Morning Post print edition as: Yellen cautions against demands for stable yuan