The US should cheer a falling yuan

See the latest Australian dollar analysis here:

Macro Morning

As we know, CNY is now falling precipitously:

FTAlphaville tapped the brain’s trust:

We got in touch professor Pettis to find out.

First, he noted that a 1-1.5 per cent appreciation of the renminbi is roughly equal to the potential impact on the Chinese economy of a 10 per cent tariff (as threatened by Trump). This, according to Pettis, gives the world some idea about how much the currency would have to move to offset the impact of tariffs.

But, the devaluation tactic isn’t as straightforward an offset to tariffs as many might think.

From Pettis:

There are three problems with devaluing the currency, however.

First, it works for China by spreading the cost of US tariffs on to all of China’s trading partners, and not just to the US, which may only increase global tensions.

Second, it may raise further concern among wealthy Chinese worried about protecting the value of their wealth and so intensify flight capital.

And finally, a devaluation works by transferring income from net importers, who in China are the household sector, to net exporters and those long dollars, ie the tradable goods sector and the central bank. As the PBoC [People’s Bank of China] has pointed out many times before, in order to reduce its reliance on debt for growth, China needs to do the opposite, ie rebalance income in favour of ordinary households.

The last point is particularly noteworthy. If the aim of tariffs is to force China to rebalance its economy quicker (in a bid to bring balance to the global economy), then tariffs — by encouraging a devaluation reaction — arguably inhibit the rebalancing rather than encourage it.

Which is why Pettis thinks the devaluation is mainly for signalling purposes and doesn’t represent a fundamental part of Beijing’s strategy to adjust to Trump’s trade war.

To that end, he highlights the following chart from David Dollar, which calculates the changes in year-to-date US trade imbalances. What’s notable is that the decline in the US bilateral deficit with China was more than countered by the increase in US deficits to the rest of the world.

Interesting no?

The point being, there’s a good argument to be made that tariffs won’t affect either the overall US deficit or the overall Chinese surplus — they may just shift around the imbalances.

I’m not so reassured because I don’t think Trump’s [only] aim is rebalance the Chinese economy. Rather, it is to prevent its development into a high end value added economy. In that sense, tariffs work just fine because they force global supply chains out of China, a reversal of investment flows, slowing its access to international IP.

If that is the case then a falling yuan is not necessarily a part of any Chinese trade war strategy. It is simply the inevitable consequence of stagnating Chinese growth as deflation flourishes and interest rates fall away.

ANZ mulls how far it might go:

  • the weak fixing is the first sign that the Chinese authorities are now finally willing to adopt a hands-off approach and allow the exchange rate to be market-determined. After numerous attempts in recent years to prevent the yuan from weakening past the 7 level, they have decided to let it go
  • it is not inconceivable that we could see the offshore yuan heading towards the 7.15-7.20 level in the near-term.
  • And if indeed it were the case that the currency were to completely offset the full impact of the US tariffs including the 10% to be imposed on 1 September, then that would imply a level closer to 7.40, though we think that would be a step too far.

Chinese authorities can influence the timing of the move but not the trend, not so long as they have a dirty float, the yuan will sink as capital flows out of emerging markets generally:

The only way to stop it is to further shut the capital account. That is, further remove China from the global economy which is what the US wants anyway.

I’m not sure Trump even realises it but a falling CNY is telling him he is winning his war on Chinese development.  A fact that has escaped the US Treasury today:

The Omnibus Trade and Competitiveness Act of 1988 requires the Secretary of the Treasury to analyze the exchange rate policies of other countries. Under Section 3004 of the Act, the Secretary must “consider whether countries manipulate the rate of exchange between their currency and the United States dollar for purposes of preventing effective balance of payments adjustment or gaining unfair competitive advantage in international trade.” Secretary Mnuchin, under the auspices of President Trump, has today determined that China is a Currency Manipulator.

As a result of this determination, Secretary Mnuchin will engage with the International Monetary Fund to eliminate the unfair competitive advantage created by China’s latest actions.

As noted in the most recent Report to Congress on the Macroeconomic and Foreign Exchange Policies of Major Trading Partners of the United States (“FX Report”), China has a long history of facilitating an undervalued currency through protracted, large-scale intervention in the foreign exchange market. In recent days, China has taken concrete steps to devalue its currency, while maintaining substantial foreign exchange reserves despite active use of such tools in the past. The context of these actions and the implausibility of China’s market stability rationale confirm that the purpose of China’s currency devaluation is to gain an unfair competitive advantage in international trade.

The Chinese authorities have acknowledged that they have ample control over the RMB exchange rate. In a statement today, the People’s Bank of China (PBOC) noted that it “has accumulated rich experience and policy tools, and will continue to innovate and enrich the control toolbox, and take necessary and targeted measures against the positive feedback behavior that may occur in the foreign exchange market.” This is an open acknowledgement by the PBOC that it has extensive experience manipulating its currency and remains prepared to do so on an ongoing basis.

This pattern of actions is also a violation of China’s G20 commitments to refrain from competitive devaluation.  As highlighted in the FX Report, Treasury places significant importance on China adhering to its G-20 commitments to refrain from engaging in competitive devaluation and to not target China’s exchange rate for competitive purposes. Treasury continues to urge China to enhance the transparency of China’s exchange rate and reserve management operations and goals.

The US is caught between conflicting investment and trade goals on China. It should cheer the yuan fall as it describes a China carved from the global economy, not worry about its increasing competitiveness in low end rubbish.

David Llewellyn-Smith

David Llewellyn-Smith is Chief Strategist at the MB Fund and MB Super. David is the founding publisher and editor of MacroBusiness and was the founding publisher and global economy editor of The Diplomat, the Asia Pacific’s leading geo-politics and economics portal.

He is also a former gold trader and economic commentator at The Sydney Morning Herald, The Age, the ABC and Business Spectator. He is the co-author of The Great Crash of 2008 with Ross Garnaut and was the editor of the second Garnaut Climate Change Review.

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