China currency wars FX yuan

Here’s How Far The Yuan Will Have To Fall To Offset Trump’s ‘All-In’ Tariff Scenario

Potentially, there's a long way to go yet.

Donald Trump lost his patience entirely on Monday evening, branding China a currency manipulator after a day likely spent glued to Fox Business watching the Dow plunge by more than 900 points at the lows.

The decision to make official what Trump says all the time on Twitter is yet another extraordinary escalation in what now looks set to spiral into an all-out global currency war.

The real irony will be when Trump instructs Steve Mnuchin to intervene in the FX market to bring down the dollar, thereby making the US a “manipulator” too.

Read more: It’s All-Out War As Steve Mnuchin’s Treasury Designates China A Currency Manipulator

In any event, Trump’s main gripe with the yuan (and the euro and the yen and the [fill in the blank]) is that currency weakness from America’s trade partners makes it more difficult for the administration to squeeze the rest of the world with tariffs.

As ever, the whole charade is maddeningly circular. The threat of tariffs (and their imposition) prompts currency weakness as the market anticipates a hit to growth and a monetary policy response. Trump then points to that weakness as evidence of “manipulation” despite having played a role in causing it both actively (by hitting other countries with tariffs, thereby denting their growth prospects and raising the odds of looser monetary policy in other locales) and passively (by juicing the US economy with fiscal stimulus, thereby exacerbating the divergence between the economic fortunes of America and its trading partners).

Around this time last year, it was readily apparent that an acute bout of yuan weakness had effectively offset US tariffs, in some cases before they were even implemented. Now, we’re back in the same situation, asking ourselves how far the yuan needs to fall in order to preempt the next prospective round of duties from “Tariff Man”. BofA has done that math.

“The far right column shows the actual USD/CNY rate relative to the implied level of USD/CNY required to offset tariffs”, the bank writes, describing the table below which appears in a Tuesday note.

(BofA)

“What is interesting is that the actual rate of CNY in markets was weaker (above 6.8) than that required to offset the tariffs until May this year when Trump raised tariffs to 25% on USD200bn of Chinese goods, which implied a USD/CNY7.00 required to offset the tariffs”, the bank’s Asia FX team goes on to say.

In other words, China held back during the May escalation in hopes that things would calm down. But, last week’s threat was the straw that broke the camel’s back.

“The latest September 1st tariff announced ratcheted this implied rate to 7.34 and may have tipped the balance for Chinese policy makers to sanction a move above 7.00”, BofA says.

The two simple takeaways from the table above are that if Trump goes ahead with a 10% tariff on the remaining $300 billion in Chinese imports on September 1, the yuan needs to fall to 7.34 to offset those levies.

If Trump goes “all-in” and slaps 25% levies on those goods, the yuan needs to drop all the way to 7.87. If Monday was any indication, markets will be in for a world of hurt if Beijing countenances that kind of shock devaluation.

Oh, and don’t forget that last week, Trump casually suggested that 25% is not, in fact, “all-in”. Apparently, he’s at least considered going even further than that. One shudders to think what that would entail.


 

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6 comments on “Here’s How Far The Yuan Will Have To Fall To Offset Trump’s ‘All-In’ Tariff Scenario

  1. Walter- what will be the impact in China’s economy @ 7.34 yuan to the dollar? I would like to hear about that.

  2. Bad news for Japan and Europe (esp Germany), as neither is likely in a position to aggressively devalue JPY or EUR (not least because neither wants to invite US sanctions).

  3. I too am curious about the negative effects to China of a weaker CNY.

    Off the top of my head, I’d think the CNY/USD change will be pretty manageable for China. China’s $120 BN top goods imports from US are (from a US govt website): aircraft ($18 billion), machinery ($14 billion), electrical machinery ($13 billion), optical and medical instruments ($9.8 billion), and vehicles ($9.4 billion), agricultural products ($9.3 billion).

    These will become more expensive for Chinese buyers. But aircraft buys are probably disrupted by 737 Max problem, BA will cut prices if need be, and there’s always Airbus. Higher machinery and instruments will hurt Chinese companies but some are probably easing back on capex just like US companies, and there must be alternatives from Germany, Japan, etc. Ag buys are supposedly interrupted anyway. Chinese govt can use targeted tax and tariff relief, social payments to soften these impacts and anyway Xi is Leader for Life, no 2020 election for him.

    China’s $59 BN services imports from the US are led by software, trademark (media), travel and transport. The latter two categories are slumping anyway, with fewer Chinese traveling to US for tourism or study. I imagine Chinese govt wouldn’t mind US media losing share to the increasingly mature Chinese entertainment industry.

    (In contrast, US imports $540 BN of goods and $18 BN of services from China, a far larger sum.)

    However, I don’t have any good sense of is how much this will increase China’s import bill from the rest of the world. China imports about $2 TR, which is (from some random website source):
    Electrical machinery, equipment: US$521.5 billion (24.4% of total imports)
    Mineral fuels including oil: $347.8 billion (16.3%)
    Machinery including computers: $202.3 billion (9.5%)
    Ores, slag, ash: $135.9 billion (6.4%)
    Optical, technical, medical apparatus: $102.5 billion (4.8%)
    Vehicles: $81.5 billion (3.8%)
    Plastics, plastic articles: $74.9 billion (3.5%)
    Organic chemicals: $67.4 billion (3.2%)
    Gems, precious metals: $62 billion (2.9%)
    Copper: $47.6 billion (2.2%)

    All the commodities (oil, ore, etc) are declining in price anyway, so even if bought in USD the bill will probably go down. But the machinery and equipment and other manufactured stuff is a huge bill (like $1 TR) so if that effectively costs 20% more in CNY, I’d think it will be hard to absorb that blow without big pain. So, cross rates like CNY/EUR etc will be critical.

    I don’t know enough about trade flows and FX – is it possible that USD will go up against CNY without CNY going down as much against JPY EUR GBP etc? Or can China play with tariffs to ease the blow to its own importing companies?

  4. Thanks, Walt!

  5. Is this just theory, or is it possible? I know in the past Heis has said that at some point past 7, China has risks to capital flight. They seem to control things pretty tight, within a tenth of a point. But I have no sense as to how close we are to that breaking point. Maybe they’re just control freaks and holding the line even though they could devalue much further? And holding just over 7 is a message to the US, as well as their own people, that their economy won’t wreck if that level is breached? I see historically that’s it has been as high as 8.73.

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