They say you can’t fix stupid, which I suppose means the world shouldn’t get its hopes about about the upcoming trade talks between China and the U.S.
On Wednesday, China’s Ministry of Commerce said the U.S. has invited a Chinese delegation to Washington later this month, ostensibly to try and break a stalemate on trade before the Trump administration moves ahead with tariffs on an additional $200 billion in Chinese goods. That escalation, if realized, would trigger a response from Beijing in the form of differentiated duties on $60 billion in U.S. imports, setting the stage for the Trump administration to “go to $500 billion” (as the President put it last month).
According to the New York Times (and there were similar reports out on Thursday), Steve Mnuchin will attempt to pressure China to strengthen the yuan when the two sides meet in Washington.
“In its coming talks, the Treasury Department will seek to pressure the Chinese to lift the value of their currency,” the Times writes, citing a person briefed on the plans and adding that “additional American tariff measures going into effect in coming months could further push down the value of the renminbi against the dollar, complicating those efforts.”
Trying to process the kind of narcissistic delirium that’s behind this “strategy” is quite challenging. This represents the U.S. effectively demanding that China shoot itself in the foot by actively strengthening the currency, thereby making Trump’s tariffs more effective. That would be absurd enough on its own (why would China agree to that?), but it’s made immeasurably more ridiculous by the fact that the yuan is being driven lower by two factors, both of which are the result of U.S. policy decisions.
First, as alluded to by the Times, the more tariffs Trump threatens, the more depreciation the market expects in the yuan and those expectations end up manifesting themselves in a weaker renminbi. Second, to quote BofAML’s Ethan Harris, “the US is running a trifecta of dollar-positive macro policies” as enumerated below:
- Easy fiscal policy pushes up the dollar by boosting interest rates and stimulating imports. The new tax laws also create incentives to repatriate cash to the US and if these monies are not already in dollar assets, this could strength the dollar as well.
- Fed tightening also pushes up interest rates, boosting the dollar.
- And actual and threatened US tariffs strengthen the dollar as well. Tariffs tend to weaken imports, reducing US demand for foreign currency, and threatened tariffs add to global uncertainty, pushing up safe-haven currencies like the dollar.
Sure, China could actively lean against the wind by hiking rates in open market operations, refraining from reserve requirement cuts and eschewing efforts to ensure that liquidity remains ample, but that would materially worsen the country’s economic outlook, could very well catalyze more defaults and perhaps most importantly, it’s not clear it would even work when it comes to closing the policy divergence with the Fed, which is at the heart of the yuan’s depreciation.
Beijing has obviously countenanced yuan weakness over the past three months and indeed, the currency’s rapid weakening versus the dollar served to completely negate the effects of the first two rounds of 301-related tariffs from the U.S.
“Our estimate implies that a 10% depreciation in CNY TWI could lead to a 5pp increase in exports, or 70bp in GDP, with roughly 3 quarters’ lag”, Goldman wrote, in a note out last month, adding that “based on these estimates, the roughly 6% CNY TWI fall since the mid-June peak should map to a 40-50bp support to GDP, which would essentially offset the estimated direct growth drag from the first two rounds of US tariff measures (the 25% additional duty on $34bn+$16bn and 10% on another $200bn of Chinese goods).”
“The recent nearly 10% drop in CNY matches the 2017 USD decline, and coincidentally neutralizes the 10% proposed tariffs on Chinese exports to the US”, JPMorgan’s Marko Kolanovic said, in a note dated July 30.
“The USD/CNY move since March has almost completely offset the impact of Trump’s potential tariffs before they have even happened”, Deutsche Bank remarked, in a note published five weeks back, before going on to rather dryly quip that “perhaps this is why the US President’s Twitter feed has turned back to talking down the dollar.”
Yes, “perhaps” it is. The reference there is of course to Trump’s July 20 tweets which found the President railing against Chinese and European “currency manipulation” and accusing Jerome Powell’s Fed of “hurting all that we’ve done” with rate hikes. “The U.S. should be allowed to recapture what was lost due to illegal currency manipulation and BAD Trade Deals”, the President declared.
Implicit in that egregious “covfefe” is the notion that the weakening yuan is keeping the U.S. from “recapturing” lost industrial greatness through tariffs. In other words, that tweet was an accidental admission of near-term defeat and it raised concerns about whether Trump would try to compel Treasury to intervene in the FX market.
The prospect of U.S. intervention is raising more than few eyebrows of late. We talked about it extensively last week in “Presenting, The Dollar Intervention Delusion“, in which we quoted JPMorgan’s Michael Feroli, who broached the subject in a widely circulated note dated August 7. In that note, Feroil made two important points about the yuan, one of which was this:
A different policy option more narrowly focused on China would be to conduct “countervailing currency intervention.” The gist of this policy would be to purchase yuan by issuing dollars to offset Chinese purchases of dollars financed by yuan creation. The intent is to neutralize the impact of Chinese intervention on the exchange rate between the two currencies, thereby checking what some news outlets have referred to as a “weaponized yuan.” One obvious problem with this policy is that even some of its staunchest past advocates, such as Joe Gagnon and Fred Bergsten, concede that China is no longer manipulating its currency to keep it artificially cheap. If anything, in the last few years, China has struggled to keep its currency from depreciating excessively in the face of continued capital outflow pressures.
In other words, recent depreciation in connection with the tariff threats and Fed hikes notwithstanding, Trump would have a hard time making the case that the Chinese are in fact actively trying to depreciate the currency. Indeed, you could even argue that they haven’t “actively” tried to depreciate the yuan in the last three months – that’s a little disingenuous because when you have a managed currency, doing nothing in the face of rapid depreciation is actually akin to doing something, but you get the point.
Remember, the yuan is just now starting to weaken beyond where it was last summer when the PBoC deliberately engineered a rally by introducing the counter-cyclical adjustment factor. Recently, in an apparent effort to keep the currency from hitting the psychologically important 7-handle which could trigger capital flight, officials in Beijing have done three things: reinstated forwards rules (August 3), chided onshore banks for selling RMB (August 7) and moved to squeeze offshore liquidity (August 16). Here’s an updated version of our annotated CNY chart:
That’s it. That’s all they can do. As BNP’s Ji Tianhe put it on Thursday, “the three channels of downward pressure on the RMB are now restricted”.
Theoretically, China could start using the counter-cyclical adjustment factor to guide the daily fix and then, as a last resort, start selling reserves. But again, it’s not clear why they would do that until there are convincing signs of capital flight and if July’s reserves data is any indication, there aren’t. At least not yet.
What Steve Mnuchin will be asking China to do if he does indeed try to pressure them to actively strengthen the yuan, is to help Trump’s tariffs be more effective or, more poignantly, help Trump “Make America Great Again”.
Actually, it’s even more absurd than that. Again, it is Trump’s domestic policies that are forcing the Fed to lean hawkish and it is that hawkish lean that is piling pressure on the yuan. Trump’s comments about Powell last month suggest that if he (Trump) has to, he’ll demand the Fed cut rates. In the meantime, he’ll apparently instruct Steve Mnuchin to effectively ask China to shoot themselves in the foot by offsetting Fed hikes with interventions in the FX market to strengthen the yuan. And yes, that is just as ridiculous as it sounds.
It’s even more ridiculous when you consider the fact that China has already taken three steps to arrest the yuan’s slide in the past two weeks. So it’s not clear what exactly Mnuchin would ask them to do in order to further support the yuan. Surely Mnuchin isn’t foolish enough to think he can convince them to hike and even if he could, hike what? Which rate? The PBoC has a bevy of rates that are all, in their own way, “key” to something.
For fun, let’s just extrapolate the most ridiculous possibility for what China could do on the way to satisfying Trump’s desire for a stronger yuan, because this, perhaps more than anything else, drives home just how absurd this situation really is.
It looks to me like China is out of options when it comes to supporting the yuan save two things. As mentioned above, they could simply start leaning on the counter-cyclical adjustment factor, but that represents a rolling back of liberalization. Or – and here’s the punchline – they could sell U.S. Treasurys to support the currency.
So is that what Steve Mnuchin is going to ask China to do? Does the Treasury Secretary want the Chinese to become an active seller of the very thing he’s selling to finance the tax cuts? Is that how far Donald Trump has plunged into his own insanity loop? Is he going to try to compel the Chinese to sell their U.S. debt in order to bolster the yuan so his tariffs are more effective only to see the whole thing boomerang on him when the liquidation of Treasurys by China triggers a selloff in global markets that sends investors clamoring for safe haven Treasurys which then drives up the dollar anew?
Again, you can’t fix stupid.