As the U.S. Department of the Treasury is expected to announce a currency report soon, market attention is focused on whether China will be designated as a currency manipulator. Should such a designation materialize, tensions between the U.S. and China may escalate further, resulting in a significant short-term depreciation of the yuan. The Korean won, which is highly correlated with the yuan, is also expected to move in the same direction, increasing upward pressure on the won-dollar exchange rate.
According to the financial sector and others, the U.S. Department of the Treasury has traditionally released and submitted currency reports to Congress in two halves each year. Generally, this occurs in April and October. Although the timing of this year's announcement has not been confirmed, there is a prevailing expectation that it will be made public no later than next month.
◇ China designated as a currency manipulator in 1992 and 2019... Increased volatility of the yuan
The designation of a currency manipulator is based on the Comprehensive Trade Act established in 1988. Under this law, the U.S. Secretary of the Treasury may designate a country as a currency manipulator if it records a significant trade surplus and a considerable current account surplus with the United States.
The U.S. can demand the currency and trade surplus adjustments from a designated currency manipulator, and if improvements are not made within a year, sanctions may be imposed. These include restrictions on investment by U.S. corporations, limitations on federal government procurement contracts from the designated country, and additional monitoring requests to the International Monetary Fund (IMF).
In response to ongoing criticisms that these criteria are arbitrary and ambiguous, the U.S. created the Trade Facilitation and Trade Enforcement Act in 2015 to clarify these standards. According to the Trade Facilitation and Trade Enforcement Act, a country is designated for in-depth analysis if it meets the following three criteria: a trade surplus in goods and services of over $15 billion, a current account surplus exceeding 3% of gross domestic product (GDP), and net purchases of foreign currencies by monetary authorities exceeding 2% of GDP for more than eight months. Typically, countries designated for in-depth analysis are understood to have the same meaning as a currency manipulator.
China was first designated as a currency manipulator in 1992. Despite recording a large current account surplus with the U.S. since 1990, the yuan was deemed undervalued and the exchange rate system was not improved. Subsequently, China made efforts to improve by establishing a joint committee for exchange rate system reform with the U.S., and two years later, the U.S. lifted the currency manipulator designation on China.
However, on August 5, 2019, after 25 years, the U.S. Treasury once again designated China as a currency manipulator. The U.S. made this decision based on the Comprehensive Trade Act, even though China did not meet the requirements of the Trade Facilitation and Trade Enforcement Act. At that time, the Treasury noted, "China has taken specific steps to lower its currency value," adding that "there is a long history of China facilitating currency depreciation through sustained and large-scale interventions in the foreign exchange market."
This decision has led to increased volatility in the yuan's exchange rate in the market. According to the Korea Institute for International Economic Policy, the dollar-yuan exchange rate rose steadily from 7.0352 yuan on August 5 to 7.1528 yuan on August 26. This was the highest level since February 2008. The People's Bank of China issued bonds worth 30 billion yuan to absorb liquidity, but it could not prevent the yuan's depreciation. The dollar-yuan exchange rate stabilized only after the signing of the U.S.-China Phase 1 trade agreement in January of the following year.
◇ A new designation as a currency manipulator would affect Korea as well... Volatility of the won is expected to increase
There is a forecast in the market that the U.S. is likely to designate China as a currency manipulator again this time. This is because there has been a precedent during the Trump administration when China was designated as a currency manipulator, and recently, Steve Mihran, Chairperson of the White House Council of Economic Advisers (CEA), suggested multilateral currency adjustment discussions as a way to address dollar strength, similar to the 'Mar-a-Lago Agreement.' The Mar-a-Lago Agreement aims to encourage trading countries to replace short-term U.S. government bonds with maturities of 10 years or less with ultra-long-term bonds maturing in 100 years, thereby lowering the value of the dollar.
If China is designated as a currency manipulator, the Korean won, which has a high correlation with the yuan, could also experience increased volatility in the short term. During the previous designation in 2019, the won-dollar exchange rate rose above the psychological barrier of 1,200 won, following the trend of the yuan. On September 3, when the dollar-yuan exchange rate surged to 7.18 yuan, it had jumped to 1,215.60 won.
A surge in the exchange rate could exacerbate financial instability and impact the monetary policy of the Bank of Korea. The Monetary Policy Committee decided to maintain the benchmark interest rate during its meeting on the direction of monetary policy held on the 17th, citing the high exchange rate and household debt concerns. Some analysts anticipated a possibility of rate cuts based on the recent decline in the won-dollar exchange rate from the 1,480-won range to the 1,410-won range; however, the Bank of Korea took a cautious stance. Should the exchange rate rise further, the timing for interest rate cuts may be postponed.
If the U.S.-China negotiations do not reach a quick resolution and prolong, negative repercussions for the real economy are expected. This is likely to lead to a slowdown in China's economy and a potential decrease in South Korea's exports to China. Kim Jin-wook, an economist at Citibank, noted in a report released on the 22nd that even if the U.S. lowers tariff rates on South Korea, the country's economic growth rate could decline by 0.5 percentage point if there is no significant progress in the U.S.-China negotiations.
Lee Seung-heon, a professor at Soongsil University Graduate School of Business (former vice governor of the Bank of Korea), warned that "As South Korea has maintained a close relationship with China for over the past 20 years, if the competition between the U.S. and China intensifies, it could be one of the countries heavily affected" and added that "if China is designated as a currency manipulator, the Korean economy will also face direct and indirect burdens that are hard to avoid."