Trumpian currency intervention is a bigger risk than China weaponising the yuan
Originally published in The Australian.
On the campaign trail, Donald Trump frequently threatened that, if elected, he would on day one label China a currency manipulator. In office, however, he demurred, only to launch a trade war with China that has gone beyond anyone’s initial expectations. This week, Trump finally delivered on his campaign promise. The US Treasury labelled China a currency manipulator after Beijing allowed the yuan to move past the symbolic level of seven to the $US.
Amid a bitter ongoing trade war, the latest developments have sent shockwaves through markets and left many speculating.
Most recognise that, while China had engaged in extensive currency manipulation in the past, it is no longer doing so, even by the American Treasury’s own standards. In fact, in recent years, China has if anything been acting to prop up the value of the yuan, after destabilising capital outflows were experienced in 2015 and 2016. For similar reasons, China truly “weaponising” the yuan is highly unlikely. The risk of prompting renewed capital outflows is a far bigger threat to China’s economy than Trump’s tariffs.
True, the yuan has breached seven to the $US — a level the People’s Bank of China had previously acted to defend. But there is nothing magical about the seven marker, a point PBoC governor Yi Gang has made publicly. Weighted against its major trading partners (a more holistic view), China’s currency has weakened in the past few months, but is still close to its average since 2016, suggesting no great misalignment. Trump’s tariffs also imply some depreciation of the yuan is to be expected as the Chinese economy adjusts to weakening exports. Greater exchange rate flexibility should also be welcomed in terms of China moving towards a more market-oriented economy, rather than criticised.
It is also well-recognised that designating China as a currency manipulator by itself carries limited direct implications. US Treasury Secretary Steven Mnuchin will now take the case to the International Monetary Fund. But the IMF has already very recently concluded China is not manipulating its currency and in any case would only launch its own consultations with China if it found that it was. Other measures the US might adopt include denying Chinese firms US government contracts and taking currency manipulation into account in trade negotiations.
In other words, the designation itself lacks teeth. Nonetheless, the move to label China a currency manipulator is significant. First, it will provide political cover for Trump’s tariffs and perhaps other forms of escalating economic conflict. Second, Beijing’s decision to allow, rather than resist, movement beyond seven to the dollar would appear to reflect a willingness to antagonise Trump and therefore also engage in escalating economic conflict even if it is not actually weaponising the yuan itself.
What if Trump does in fact try to directly counteract China’s alleged currency manipulation? One possible avenue for doing so would be for the US Treasury to begin implementing countervailing currency intervention. This would work by purchasing Chinese yuan-denominated assets to bid up the value of the yuan and cancel out the effects of any currency manipulation by Beijing.
But if China hasn’t been manipulating its currency lately, then, rather than combating manipulation, the US would instead be acting as a currency manipulator itself. The US would simply be seeking to push down the dollar to gain a competitive advantage. Not only would this be hypocritical but, if successful, it could also prove highly destabilising to the global economy. The political whims of the US president would now be trying to dictate the value of the world’s reserve currency upon which most global trade and cross-border finance is anchored and to which global investors flock to in times of uncertainty.
It would also raise big questions about the sustainability of America’s persistent current account deficits and the willingness of the world’s investors to continue financing this and in doing so granting the US the “exorbitant privilege” of borrowing as much as it wants in its own currency.
Trump would effectively be taking bold steps towards unwinding the US dollar’s pre-eminent role in the global economy. To add further oddity, America would instead be accumulating official reserve assets in Chinese yuan, bolstering the role of the yuan as an international reserve currency.
The US Federal Reserve for its part would be left in a bind. Trump has repeatedly called for lower interest rates and a cheaper currency to help him win his trade war with China (and the next US election). Fed chair Jerome Powell has repeatedly asserted the Fed’s independence. But the more a populist American president destabilises the US and global economies, the more a technocratic Fed feels compelled to offset this by lowering interest rates. It’s a perverse relationship that unfortunately seems destined to continue. Ultimately, if Trump truly wants a weaker dollar and shows he is prepared to act, then there will be little stopping this from becoming a reality. After all, who would want to hold the US dollar then?
None of this is to be welcomed by Australia or other nations. The Australian dollar has moved lower in a typical response to increased risk aversion among global investors. If sustained, that might theoretically boost our exports and help lift inflation. But more likely it would prove poor compensation for the global damage unleashed by an ever-expanding economic conflict between the US and China. Nor a world where politics, rather than markets and technocrats, increasingly seeks to dictate the course of the global economy.