Back in August, about a week prior to what would ultimately end up being fruitless negotiations in Washington, several media outlets reported that Steve Mnuchin’s Treasury was looking to pressure Beijing into deliberately strengthening the yuan which, at the time, had been falling precipitously amid the burgeoning Sino-US trade “dispute” (that was back when you weren’t supposed to call it a “war”).
Here’s what we said about that in an August 17 post:
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.
At the time, the yuan had depreciated enough over the space of two months to completely negate the effects of the first two rounds of 301-related tariffs from the US.
“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 July note, 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.”
The reference there was 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”. “The U.S. should be allowed to recapture what was lost due to illegal currency manipulation and BAD Trade Deals”, Trump declared.
Of course the irony in all of the above is that it wasn’t entirely clear whether the yuan was depreciating because of the PBoC, or because of Trump’s policies. The more aggressive his trade rhetoric became, the more “natural” pressure there was on the yuan as the market began to anticipate that a protracted trade war could end up exacerbating the deceleration in the Chinese economy. Meanwhile, Trump’s fiscal policies were overheating the US economy, effectively forcing the Powell Fed to lean more hawkish than they otherwise might, a policy bent that led directly to a stronger dollar. At the same time, repatriation flows were dollar positive too, and the stronger the US economy became versus global peers, the more appetite there was for USD assets, thereby catalyzing hot money flows, underpinning the greenback further still.
Literally all of that was because of Trump, and while the PBoC could have certainly stepped in to arrest the slide in the yuan, they had little incentive to do so. After all, the depreciation was cushioning the blow from the tariffs and, because that depreciation was catalyzed not by “manipulation”, but rather by US policy, Beijing had all the plausible deniability they needed to sit back and let the currency offset the tariff threat.
As nice as that was, it would have been untenable past a certain point. Eventually, it would have risked triggering capital flight and so, the PBoC stepped in with a four-pronged approach to put the brakes on the slide. Once the yuan began to weaken beyond where it was in the summer of 2017 (when the PBoC deliberately engineered a rally by introducing the counter-cyclical adjustment factor), Beijing intervened in an apparent effort to keep the currency from hitting the psychologically important 7-handle. Specifically, China reinstated forwards rules (August 3), chided onshore banks for selling RMB (August 7), moved to squeeze offshore liquidity (August 16) and reinstated the CCAF (August 24).
Here’s an annotated chart of the onshore yuan which shows you how these various efforts have evolved since the 2015 devaluation (green annotations are CNY+, red are CNY-):
The yuan stabilized in late August before drifting weaker into November and ultimately strengthening from December into the new year. You’ll also recall that Mnuchin declined to name China a currency manipulator in Treasury’s semi-annual report.
Fast forward to February and with the Fed having pivoted decidedly dovish, China has more scope to ease monetary policy without risking currency depreciation. And see, this is where Trump’s policies start to trip over themselves (again). He wanted dovish cover from the Fed for his trade war and he got it, but now, China can ease further without having to worry so much about a widening policy divergence with the Fed stoking capital flight.
Additionally, the Fed’s dovish pivot paradoxically triggered dollar strength. We’ve been over the reasons for that ad nauseam over the past two weeks (see here, for instance).
It’s with all of that in mind that the US is now reportedly demanding that China promise currency stability as part of any trade deal.
“The US is asking China to keep the value of the yuan stable as part of trade negotiations between the world’s two largest economies, a move aimed at neutralizing any effort by Beijing to devalue its currency to counter American tariffs”, Bloomberg said Tuesday afternoon, citing the ubiquitous “people familiar” with the situation.
Apparently, currency policy will be included in the MOU that will serve as the centerpiece for a final deal agreed to at a future meeting between Trump and Xi. As a reminder, that rumored MOU has eluded negotiators at each round of talks held so far this year. According to the same sources, “a pledge of yuan stability has been discussed in multiple rounds of talks in recent months and both sides have tentatively agreed it will be part of the framework of any final deal.”
The article goes on to say that in the event Beijing attempts to devalue the yuan to counter the tariffs, the US would move ahead with still more tariffs.
Hopefully, you can now see why we felt it necessary to include a lengthy recap of how this played out last summer. The Trump administration doesn’t seem to understand that the threat of tariffs is in part responsible for yuan weakness and as such, it’s impossible to know, with any degree of certainty, how much of a given leg weaker in the Chinese currency when trade tensions flare is due to “manipulation” and how much is due to the market simply betting on a weaker yuan due to the read-through of the tariffs for China’s economy.
That ambiguity sets the stage for Trump to point to a weaker yuan as “evidence” of currency “manipulation” and then use that as a justification for more tariffs, which then push the yuan weaker still, in a never-ending insanity loop of his own making.
Finally, it’s worth noting that China wants a stable yuan too, so it’s not entirely clear whether it even makes sense to characterize this as a “demand” in the first place unless you want to couch it in terms of a broader strategy by the US to adopt a weak dollar policy by proxy.
With all of that in mind, we’ll leave you with one more quick passage from the Bloomberg piece and let you laugh and the sheer blatant redundancy inherent in all of the above:
The Trump administration has been clear in its talks with Beijing that any attempt to depreciate the yuan — a strategy aimed at offsetting existing U.S. duties on Chinese imports — would be met with more or higher American tariffs, according to two of the people briefed on the discussions.