Australia’s “stable” yuan problem

Via FTAlphaville:

March 1 may no longer be a “magical date” for President Trump, but the deadline after which tariffs on $200bn worth of Chinese imports are set to more than double is fast approaching.

Now in their ninth round of negotiations, the US and China remain at odds on a number of issues, despite making some progress on Wednesday. With the latest request from the US, officials may have added another problem to a long list of sticking points.

According to Bloomberg, the US has asked the Chinese to keep its currency, the renminbi, stable and to avoid any kind of competitive devaluation to offset the pain from higher tariffs on Chinese goods. As Marc Chandler of Bannockburn Global Forex notes, the reports say nothing about what “stable” actually means. Is the US looking for a Chinese currency that is stable in real or nominal terms? Or one that is stable against the US dollar or a basket of currencies?

If “stable” means the renminbi continues to trade within a band set by officials at China’s central bank on a daily basis, then according to Brad Setser at the Council on Foreign Relations, this isn’t such a large ask from the US. In fact, China has committed to this kind of policy for many years now — most aggressively since September as Setser’s chart shows:

As a result, the renminbi has remained tightly bound between a small range, as illustrated by Setser here:

But David Woo at Bank of America Merrill Lynch tells Alphaville that he thinks differently about the definition of “stable” in this context:

Stable is another word for strong currency. In other words, it’s the US telling China that it does not want to see the country go back to its beggar-thy-neighbour tactics and ultimately gain an unfair competitive advantage.

For example, the Trump administration could specify that China’s currency cannot weaken past the all-important Rmb7.0 per dollar threshold, as it threatened to do in November.

To Woo, it makes little sense why China would go ahead and acquiesce to a demand like this. As he points out: “no country in the world wants to agree to let another country set their exchange rate.”

What’s even less likely is that China would do this at a time when its economy is stalling. While credit growth roared back in January, following months of piecemeal stimulus measures, domestic demand continues to cool. To counter this, Woo argues that China will need to further ease monetary policy, which will naturally put downward pressure on its currency. By agreeing to the US’s demands for a “stable” (ie stronger) currency, China is effectively relinquishing its monetary policy independence.

Looking long-term, however, a stronger currency may not be such a bad thing for China. In contrast to Woo, Hans Redeker at Morgan Stanley believes that a Chinese concession on this currency point may be very easy to get because “a stronger renminbi is in China’s interests.” Most importantly, says Redeker, it will help to accelerate China’s transition from its “maxed out” investment-heavy growth model towards a consumption-driven one.

More bluntly, per Redeker:

“China agreeing to US demands of a stronger [renminbi] exchange rate is not too big a sacrifice to make by its authorities. The opposite may be even true. [renminbi] strength may support the necessary restructuring of China’s economy.”

Treasury officials better hope its Chinese counterparts see it that way.

They’ve never seen it that way before. It’s always been one foot forward and two back on reform.

Either way, Australia suffers. China opts for reform and the commodity trade gets hammered. Or it doesn’t and the capital account shuts cutting us off from capital inflows (as well as accelerating outflows) pounding the services trade.

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