In any case:
1) Malaysia currently floats the Ringgit.
2) Currency manipulation is not necessarily currency speculation and vice versa.
3) Most countries conduct their monetary policies independently and free from political interference. Even if this is not true, I would hesitate letting popular mandate determine monetary policy.

Think about it: when a policy like currency manipulation creates an externality in the international financial market, what regulatory system might force them to pay the cost? None, so diplomatic pressure is necessary.

My question would be: why should America encourage currency manipulation if it believes the risk is unacceptable?

“It’s not about the risk to them, its about the risk to us. In all likelihood [interest rate "manipulation"] will work out fine for the other country, but it creates a situation where countries are playing by different rules. So when X criticizes Y, it is doing so out of its own interest.

When a policy like interest rate “manipulation” creates an externality in the international financial market, what regulatory system might force them to pay the cost? None, so diplomatic pressure is necessary.

My question would be: why should X encourage interest rate “manipulation” if it believes the risk is unacceptable?

(Another question: what is the difference between a fixed exchange rate regime and currency “manipulation”? Are both always the same?)

Nonetheless, externalities are a third-party costs incurred to an economic agent not part of a transaction. Therefore, to qualify as an externality, another economic agent, say, Z, has to bear the cost, rather than X or Y. If indeed an externality has been imposed on the international financial market, shouldn’t Z raise the issue instead of X or Y? Could it be that there exist flaws in my definition of an externality?

Is it not arguable also that currency “manipulation” by X might be good for Y – in the sense that Y pay less for certain things? Maybe people in Y do not want cheap goods?

(Re-emphasis: I’m speaking in theoretical terms, not about particular countries.)

Please bear with me if I appear ignorant =/ =| =\ I have not studied economics for more than a year. Sorry!

You don’t have to be polite in your comments – just state your arguments and correct my mistakes plainly and directly. You will be doing me a huge favor by helping me unknot this particularly difficult puzzle and improve my understanding of economics.

Thanks to all who have replied thus far!

*untie this particularly complicated knot

it seems misleading to use this concept in macroeconomic issues: on the aggregate every effect affects a party and it is difficult to see how that effect is left uninternalised if the affected party is vaguely rational.
when secondary effects (which predominantly affect the relevant parties anyway, not third-parties) such as trade imbalances result, how useful is it to talk of the lack of a ‘market’ for such effects?
plus, it seems weird to talk about externalities arising from the consumption or production of currency. its sole role being the enabling of market pricing, i dont think currency should be seen as a ‘good’.

>Addition to my previous comments
I quote B’s comment:
“It’s not about the risk to China, its about the risk to America. In all likelihood it will work out fine for the other country, but it creates a situation where countries are playing by different rules.”

Now, is the practice “wrong” because the rules are not being followed, or because it is bad for the world?

In the former case, who decides the rule? Does God decide the rule because God is God, or does God determine the rule because it can explained convincingly through arguments and good economics? In the latter case, appealing to a rule-based argument is absolutely unnecessary. Simply say, “You have gotten the economics wrong, and there are severe consequences if that is not corrected.”

I certainly don’t mind being known as the investor who breaks the central bank of country X.

My question is, why should this be an economic or ethical issue? The only question, again, seems to be what is in a particular countries interest.

I don’t really understand the transactional model of externality Ian put forward: it doesn’t seem necessary to say that every externality will occur in an exchange between two parties, X and Y, and further, that it must effect a third party Z. The factor that pollutes one farmer’s pond is still creating an externality. I do think, however, that even if an uninvolved party has to be effected by intervention in a particular exchange rate, moral hazard would still mean that Z would very likely be forced to bear a cost.

even more interestingly, if i am not wrong, concerted manipulation of exchange rates, i.e. all fixed, is in effect equivalent to the institutionalisation of a global currency and it remains to be seen if that is an undesirable result. but well i still think its unfair to accuse one country of gaining ‘unfair advantages’ over another by sole virtue of the fact that the defendant purposefully mainpulates its own currency.