Of course, Dr. Murphy is correct. The price of anything adjusts to clear the market. Governments can “manipulate” the price of anything by participating in the market for it either as a buyer or seller. The quantitative effect of a government’s manipulation depends on its relative size as a participant compared to the overall market. If a government wants to increase the price of something, it can buy more of it and if it wants to decrease the price of something it can sell more of it. Of course, the effect on price from a one-time purchase or sale of something will be temporary. To have an ongoing effect of keeping price up or holding it down, the government must have an ongoing larger demand or an ongoing larger supply.
To determine whether or not a government is manipulating its currency, then, one would have to know the world volume of trade in its currency for the foreign currency and the government’s volume of trade in its currency for the foreign currency. As you might suspect, unlike the former the latter is not public information.
Lacking knowledge of the Chinese government’s actual participation in foreign exchange markets, we as outsiders are left to speculate among the logical possibilities. Maybe the Chinese government is massively (see below for how massive it would need to be) intervening in the foreign exchange markets for its currency. But maybe, the merchandise trade deficit America runs with the Chinese and its matching capital account surplus are merely reflections of preferences Americans and Chinese have. And maybe the exchange rate is being driven by some combination of government manipulation and market forces.
Here is a chart of China’s currency exchange rate against the USD:
If you click on the “5 year” button, you can see that the Chinese currency has traded in a rather narrow band of 6.6 to 6.0 USD.
Here are China’s Foreign exchange holdings:
For the last five years, the Chinese holdings of assets for conducting foreign exchange trade have steadily increased.
Here is foreign exchange trading worldwide:
As you can see, foreign exchange trade is huge. The average volume of trade each day in April 2013 was $5.3 trillion. The USD-CNY volume of trade was 2.1 percent of the total or $111 billion per day.
If the Chinese government is selling its foreign exchange reserves (which are around $3.7 trillion) to support pegging its currency to the USD at 10 percent of the market (i.e., $11 billion a day), it would exhaust its entire holdings in just one year. If the Chinese government is hoarding up its foreign exchange holdings to support pegging its currency to the USD at 10 percent of the market, it would double its entire holdings in just one year. As noted above, however, Chinese foreign exchange holdings have slowly increased over the last 5 years.
There is one other point to note. Under certain conditions, a government could manipulate other participants in the foreign exchange markets to increase their demands or supplies and thereby, avoid doing its own buying and selling. As a superpower country, The U.S. government did this to other countries under Bretton-Woods. Some commentators claim that the Chinese can scare foreign currency traders into inaction by threatening to counter their trades using its own huge foreign reserve holdings. If the Chinese government is doing this, however, there is no way for an outsider to know it. We must speculate from the evidence we have, which is always open to different interpretations.