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Currency wars – US-China trade dispute being played out in the Forex markets

  • Chinese authorities take a break from supporting their currency, causing a price drop
  • Sharp fall in the value of the Chinese yuan against the dollar takes it past key $7 level
  • US officially names China a ‘currency manipulator’
  • Actions from both sides are making a resolution to the trade war less likely
  • Beijing’s action comes as a surprise to markets, causing equity prices to fall

The US has officially named China a ‘currency manipulator’. This follows a considerable drop in the value of the Chinese yuan against the US dollar. Both events mark a significant and somewhat surprising intensification of the US-China trade wars. The markets are rattled.

Equities down

During the first trading session of the week (Monday 5th August), the Dow Jones Industrial Average index was down 2.9% and the Deutsche Börse DAX index was down 1.8%. Whilst the DAX and Dow are still showing a healthy year-to-date return of approximately 10%, the Hang Seng index is only just keeping its YTD return above zero, currently trading at 25,847, which equates to a YTD of just +0.03%.

DJIA – Five day price chart:

Source: CNN Business

Deutsche Börse DAX – Five day price chart:

Source: CNN Business

Hang Seng – Five day price chart:

Source: CNN Business

 

Currency manipulation

At first hand, the term ‘currency manipulator’ sounds like one of the many throw away insults that are currently traded between the two parties. In fact, the official term has a technical definition and more importantly comes with a set course of action.

The US Treasury department defines currency manipulation as when a country deliberately influences the exchange rate between its currency and the US dollar. This is done to gain an unfair competitive advantage in terms of international trade. The process of redress means treasury secretary, Steven Mnuchin, will now engage with the International Monetary Fund (IMF) to “eliminate the unfair competitive advantage created by China's latest actions”. (Source: CNBC)

The last time the US named a country a currency manipulator was in 1994 when Bill Clinton's administration laid the charge – again on China. There’s a theme developing here and China’s willingness to devalue its own currency has long been a point of contention. In fact, Donald Trump was drawing attention to the long-standing problem during his election campaign of 2016 and made an election promise to call out China as a currency manipulator should he be elected. The US Treasury’s statement of 5th August said:

“China has a long history of facilitating an undervalued currency through protracted, large-scale intervention in the foreign exchange market.”

 Source: Forbes

Resisting presidential calls for the ‘manipulator’ charge to be made, the US Treasury instead has had China on a watch list. The rapid devaluation of the yuan has meant the Treasury Department is now ready to take action. Its statement went on to mark a further escalation of the trade war.

“In recent days, China has taken concrete steps to devalue its currency, while maintaining substantial foreign exchange reserves despite active use of such tools in the past.”

 Source: Forbes

 China actively supports its currency by using the currency it gains through international trade to buy the yuan. The recent market move demonstrates what happens when it stops.

USDCNY 2010 – Current:

Source: TradingView

 

What next

The standard course of redress involves the two parties organising trade negotiations in an attempt to solve the issue. If these are unsuccessful, then the door is opened to tariffs being introduced. The US Treasury is also expected to work with the IMF. The first two items on this ‘to do’ list have already been tried and failed, and no-one is particularly hopeful that talks between Treasury head Steve Mnuchin and the IMF are the key to this increasingly complex situation.

The statement referring to ‘currency manipulation’ is therefore largely symbolic. It supports the US case for applying tariffs, which had to date been supported by a legal process that relied more on domestic rather than international law.

Source: CNBC

Stephen Roach, economist and senior fellow at Yale University said:

“I don’t think Beijing is going to really respond to this name-and-shame approach by the Trump administration… I think this in and of itself is an empty threat.”

 Source: CNBC

 Roach points out how the willingness of both sides to stand up to each other could either see the situation reach an impasse or send it into a tail-spin.

“But if the US does escalate further on the tariff front, or try other sanctions, then as we saw overnight, there will once again be intensification of pressure coming back from the Chinese.”

 Source: CNBC

A new threat

The USDCNY price move marks the trade war opening up on another front. The US has to date preferred the use of import tariffs as a bargaining chip. But as China has a net surplus of trade with the US, they are not Xi Jinping’s weapon of choice. The US administration’s interpretation of the currency move is yet to be revealed. Analysts have suggested the White House is planning for the US to intervene in the Forex market itself to sell the dollar. Roach sees any unilateral action as being ineffective and has said it would not work unless there is a “grand coalition of other countries that would join with the US in attempting to push the (Chinese currency) back up”.

Source: CNBC

At present, there appears to be no pressure elsewhere in the world for the formation of such a coalition.

The fundamental issues relating to US-Chinese trade are many, complex and long-standing. Whilst talk currently centres on items such as agricultural products and luxury fashion items, the underlying theme is about more than ‘beans and bags’. China’s long-standing aim is to muscle its way to replacing the US as the technological pre-eminent nation in the world.

China’s willingness to manipulate the trading relationship is a means to an end and has been noted but not addressed for years. The situation has been left to slide largely because US consumers have benefited considerably from the ability to import cheap Chinese made goods. Trump’s reaction might be too little too late. It’s unclear if the tools being used will be effective – so for now, the China administration continues to take the approach that ‘if you can do the time, do the crime’.