A step-up in US-China trade tensions

The US Treasury has officially labelled China a ‘currency manipulator', after the People’s Bank of China (PBoC) allowed the Chinese yuan (CNY) to fall below the seven-per-dollar level, which makes Chinese exports more competitive.

“This has always been my view that a worsening US-China relationship is a new norm for the medium term, which is unlikely to be resolved through near-term negotiation. Prolonged tic-and-tac negotiation will continue to weigh on corporate sentiment and on future capital expenditure (Capex), while the next tariff hike on September 1st may start to dampen consumer demand, given higher import prices.

Key policy options for China to deal with trade uncertainty are to either boost domestic demand, especially in the property market, or use currency flexibility to help exporters to mitigate the impact from the tariffs. China has made it clear that it won’t boost the domestic property market to stimulate its economy, which leaves currency one of the few options to choose. Breaking the psychological important 7 level gives the People’s Bank of China (PBoC) more flexibility in the near term.

Why did the US formally call China a currency manipulator?

US law sets out three specific criteria to label a country a currency manipulator, and China only meets one of the three, which is a trade surplus over $20bn. However, it seems that President Trump has discretion to change the rules.

What can the US do after labelling China a currency manipulator?

Not much in the short term. The US should seek to negotiate, given US-China trade negotiations have been running for over a year. The US can impose sanctions to prohibit Chinese companies for US government contracts, while Chinese companies have already been withdrawing from the US market, proactively or passively.“

“With the US labelling China a ‘currency manipulator’ overnight, could the next step be a Trump attempt to push for US dollar intervention? Perhaps not a too distant scenario, given the way the US-China trade war has escalated in the past year.

President Trump has been very vocal in lamenting US dollar strength and its threat to his economic agenda. He’s failed to rule out currency intervention when asked directly and has a good track record of following through with his warnings. The chance of getting his way is surely higher now the Treasury have labelled China a currency manipulator, and because the same department also has responsibility for setting US dollar policy.

This latest move at least levels the playing field somewhat and opens the door to a currency war, which would ‘up the ante’ in the trade war. However, it could prove counterproductive considering that in recent times, China has intervened to stop its currency from depreciating further, rather than manipulating its currency lower, as accused by the US.

China has used the “counter cyclical factor” method for setting the value of the yuan, aiming to limit volatility rather than target a specific value. Should a currency war ensue, China might be less willing to prop up the renminbi.  

While not my base case, the prospect of a US-China currency war is worrying and has risen in probability. I expect demand for safe havens to persist. Both the Japanese Yen and gold should benefit if the situation escalates. More interestingly, the Euro could be one of the biggest beneficiaries, bringing an end to 18 months of depreciation against the US dollar.”