Trump vs. the Yuan: Why He Wants China to Commit Economic Suicide

Updated on August 10, 2019
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Alex Kuptsikevich, the FxPro financial analyst (since 2007).

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The Fight for Global Dominance

The mere idea of America having a trade deal with China has become a bargaining chip of sorts. In 2019, April and May failed to deliver a deal between the two countries—while the stakes grew even higher.

One of the latest unpleasant surprises for Trump was the sudden weakening of the Chinese yuan (CNY) to more than 7.0 for a dollar these days. This is despite the Chinese National Bank doing everything it could in recent years to prevent the depreciation of the national currency lower than the key level.

However, that does not mean that a more expensive yuan will benefit China—in fact, the opposite is true. It might even turn out that the trading wars have been initiated by Trump to persuade Xi Jinping to strengthen the CNY. Interestingly, a similar tactic was used by America back in the 1980s in negotiations with Germany and most memorably with China’s neighbour—Japan.

As was the case with Japan, China is currently the second biggest economy in the world, growing at a rate twice as fast as the US economy. This dramatic growth with no overheating or volatility is based on exporting cheap goods, which has become very popular around the world.

The latest IMF prognosis (which goes up to 2024) puts the Chinese economy in second place after the US, but with growth rates being twice as fast as its large western competitor, there is little doubt that China will reach the leading position by 2030. Unless, of course, it is stopped by extreme circumstances which, by the looks of it, is something America is working hard at creating.

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Goods and Currency Manipulations

The weakening of the renminbi against the dollar makes Chinese goods cheaper than competitors. To a large extent, this helps to overcome the negative effect of the tariffs imposed by the United States.

The PBoC has sharply reduced the official rate against the closing level on Friday. However, most market participants expected that China would protect the exchange rate on the way to 7.0 as before. However, this did not happen, which launched a large-scale movement in the markets. What is more important is that market participants believe that China started to use the national currency rate as a tool in a trade war with the U.S.

As the FxPro Analyst Team supposes, if Trump is publicly pressuring the Fed to weaken the dollar and lower the rates, why can't China, whose central bank has much less independence from government influence, use the same tactics?

China will obviously have its own version: they acted on the basis of market realities, reducing the official exchange rate of the national currency in response to market pressure. The weakening of the yuan attracted attention after overcoming the significant round level of 7.0. However, the amplitude of this weakening does not look beyond the pale.

Some time ago, the US Treasury published a list of countries, which fell into the category of “manipulators of national currencies”—and China was one of them. This was marked as the beginning of strategic pressure being placed on China.

It is quite possible that the PBoC may not intervene until the decline of the national currency looks less chaotic. So far, the market reaction looks proportionate to what we saw last year and earlier this year. In 2018, the renminbi lost 10% as a result of the reaction to the first wave of tariffs. A similar amplitude of movement is capable of sending USDCNY up to 7.3–7.4 by the end of the year. The Chinese at this point probably understand that it would be economic suicide if one of the conditions of the deal with the States is their promise to strengthen the national currency rate.

From the American point of view, this meant that the Chinese administration intentionally kept the currency rate low to give itself a competitive monetary advantage. Looking at the currency rate fluctuations since 2014, the Chinese yuan has increased in value during the slow growth periods and the escalation of trade talks has pushed the National Bank to defend the currency rate.

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The Trigger

However, China does have an advantage over the US in these trade wars. They are taking their time signing a deal, mainly because they aren’t under pressure like Trump is to impress his electorate with a big trade deal before the upcoming presidential election (another one of Trump’s concealed motives).

Maybe the US president has bitten off more than he can chew going after such a big adversary? As the yuan rate is dropping, China’s economy is growing even faster, overcoming structural obstacles, while the National Bank is keeping to a policy of stimulation.

The further this all goes, the worse it could get for the US. If the Chinese feel increased pressure on them in the trade negotiations, they could open up a new round of trading wars where they would only need to take their foot off the brake and let the market push the yuan.

However, the Chinese have about $3 trillion of reserves, two-thirds of which (presumably) are dollar assets. But war means war and in a stressful situation, the dollar can become a nice retreat for the scared investors who have experienced a surge in growth. And that is the exact opposite of what Trump wanted to begin with.

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