Late Thursday, Wilbur Ross “put foreign exporters on notice that the Department of Commerce can countervail currency subsidies that harm US industries”.
The statement, which accompanied an announcement of the initiation of proposed rule-making, effectively means that in the future, the US may slap tariffs on top of tariffs if Treasury determines a given country is engaged in competitive devaluation.
The news brought to mind Donald Trump’s “dollar insanity loop“. The US has, for the better part of Trump’s presidency, run what BofA last summer described as a “trifecta” of USD+ policies. Trump’s fiscal policies turbocharged the US economy, even as the trade war undermined the rest of the world. The resultant economic divergence argued for a stronger dollar, as did the mechanical effect of repatriation. Meanwhile, the prospect of an overheating labor market (again, facilitated by Trump’s late-cycle stimulus) forced the Fed to lean hawkish and the fact that tariffs are inflationary only added to the argument for rate hikes. That, in turn, drove the monetary policy divergence between the US and its trade partners wider, another tailwind for the greenback.
At the same time, Trump’s trade war needs a weaker dollar, because the stronger the greenback, the less effective the tariffs. Again, it’s an insanity loop, and the only way out of it was for Trump to badger Jerome Powell into leaning dovish, which Powell did, but that still didn’t help because the FOMC’s global counterparts simply leaned dovish too. The dollar remains resilient.
As absurd as this situation is, it’s even sillier when it comes to China. For years, the rest of the world has demanded that Beijing allow the market to play a greater role in determining the yuan’s exchange rate. But at various intervals over the course of the trade war, the Trump administration has expressed consternation that a depreciating yuan is serving to make the tariffs less potent. Of course, it’s impossible to know what part of the yuan’s slide last summer was attributable to expectations of economic weakness tied to the escalating trade war (and, by extension, expectations of policy easing from the PBoC to try and counter that weakness) and what part was “manipulation.”
Now that the trade war is raging anew, this is going to be an issue that comes back up, especially as Beijing ponders what non-tariff retaliatory measures to deploy if Trump continues to turn the screws.
On Saturday, a speech by Guo Shuqing, head of China’s banking and insurance regulator, mocked the world’s blatantly contradictory stance towards the yuan. “Guo said the yuan’s weakness caused by the trade war makes the US government worried about the diminishing effects of higher tariffs”, Bloomberg writes, recapping the speech and adding that Guo “said it was ‘ridiculous’ that developed countries have long asked for more currency flexibility, but when the yuan’s rate become more market oriented, some of them showed fear.”
That is, in fact, “ridiculous”, although it’s equally ridiculous for Beijing to pretend as though they won’t countenance yuan depreciation if the market wills it amid the trade standoff. After all, China has little incentive not to let the currency absorb some of the hit from Trump’s protectionism. The check on that willingness is the fear of capital flight, but as we’ve mentioned on too many occasions to count, Beijing is in a much better position to cope with that now than in 2015.
As Deutsche Bank wrote Friday, so far, the CNH-CNY basis has been well-behaved. “As an export-driven economy, a weaker currency is beneficial for China to the extent that it makes Chinese exports cheaper on global markets [but] a rapid pace of depreciation could drive capital flight”, Deutsche’s Stuart Sparks wrote, adding that “during 2015 and 2016, large discrepancies between CNH and CNY resulted from increased outflows.”
Sparks – who weighed in on this from the perspective of the effect intervention might have on US Treasurys – goes on to write that “relative to the 2015-2016 experience, pressure on CNH/CNY basis widening has been far less significant… in part due to other measures that contain potential capital flight such as outright restrictions on retail dollar conversion, limits on the use of credit cards overseas, decreasing cross border lending activities of the banks, taxing domestic FX hedging instruments, and other measures.”
In other words, China has a better grip on things than they did three years ago, which means they can “safely” tolerate more depreciation. As far as Treasurys are concerned, the above suggests Beijing won’t have to resort to mass liquidations, something most observers believe they’d be loath to do anyway.
All of that said, it’s never a good idea to test the PBoC’s resolve when it comes to their tolerance for speculative bets against the currency. At times, it almost seems like it’s more a matter of pride than expedience, but whatever it is, don’t for a second forget that at any given moment, China can (and will) simply take yuan bears out back and summarily execute them.
Guo apparently reiterated that in the Saturday speech mentioned above. “[Speculators] shorting the yuan will inevitably suffer from a huge loss”, he warned, in the most explicit terms imaginable. That unambiguous assessment means nobody is going to feel sorry for anyone who gets caught wrong-footed betting on a one-way depreciation.
Still, you can hardly blame the market for thinking the yuan is headed lower. With controls in place to prevent capital flight and nationalist sentiment running at a fever pitch (which, one assumes, will make Chinese less inclined to move money out of the country for fear of being derelict in their patriotism), it makes sense that authorities would be willing to stomach depreciation if it helps water down Trump’s tariffs. The PBoC can also lean on the countercyclical adjustment factor, sell bills in Hong Kong to tighten offshore liquidity or dust off any number of other tools for stabilizing the currency if things get out of hand.
The irony, then, is that there’s a sense in which it is precisely the PBoC’s assumed ability to control the situation (i.e., prevent a currency collapse) that argues for depreciation. The less China fears capital flight and the more confident the PBoC is in its capacity to quickly stem a rout, the more inclined Beijing would ostensibly be to allow the currency to fall in order to offset the tariffs.