Beidaihe, a famous Chinese summer seaside resort, popular with tourists, is situated in north eastern Hebei province, about 300km east of Beijing. China watchers know it, though, because every year around the beginning of August, it hosts a top brass Chinese Communist Party meeting to discuss key policies. Soon it will soon kick off without fanfare, but we can be pretty sure that Donald Trump’s trade war is going to dominate talks, especially as on both sides of the Sino-US divide, warnings are being sounded of a currency war too. This would give world financial markets a bad case of the shakes.
The Chinese currency, designated in markets as CNY, has been falling for quite some time though within the limits laid down by the People’s Bank of China. Measured against the US dollar at 6.78 yesterday, it is worth 7.5 per cent less than its recent high point in late March. That point represented a nearly 10 per cent gain from the all-time low of CNY 6.96 in late 2016—bringing to an end an 18 month period of serious currency and stock market instability. The CNY is lower now in trade weighted terms than it was at the height of the 2015-16 crisis, but it is the US dollar rate that really matters.
To some extent, the fall in China’s currency mirrors the rise in the US dollar’s general appreciation against most currencies, in the wake of the US economy’s performance and the expectations of rising US interest rates. And so on one view, what’s happened to the CNY isn’t a major problem. But this isn’t all that’s been going on.
On the home front, the People’s Bank of China and other regulatory agencies have been incrementally softening their polices as evidence comes in that the financial clampdown started in 2017 is kicking in. Official GDP data don’t corroborate it but important real-time data for real estate transactions, investment and retail sales speak to a slowing economy, defaults in Chinese bond markets are rising and the stock market is reflecting economic worry.
Accordingly, the central bank has injected large volumes of liquidity by lowering banks’ reserve requirement ratios three times this year, and operated directly and in size to boost funding for loans in June and again early this week. It has encouraged banks to buy bonds with low credit status, and pressured them to negotiate work-outs with weak borrowers.
There is no question that the People’s Bank of China has quietly pulled back from the less compromising financial policies it introduced 18 months ago, and that monetary policy is acting to weaken the exchange rate, whether the authorities intended this or not.
“Moving China’s currency centre-stage would be a risky move: foreign exchange markets turn over $3trn every day”On the external side, moreover, Trump’s trade war is getting serious, and may also be undermining China’s exchange rate. By the end of this month, the United States will have levied a new 25 per cent tariff on $50bn of imports from China, which the latter will match tit-for-tat. The White House had already threatened China with a 10 per cent tariff on a further $200bn of imports if it did so, but at the end of last week President Trump—perhaps eager for a distraction from the Helsinki summit fiasco—said he was ready to impose tariffs on the entire $500bn of goods imported from China. He also reiterated his intention to levy tariffs on European Union imports, especially of automobiles and parts, and charged that China was manipulating its currency (a charge also levied at the EU). Treasury Secretary Steven Mnuchin said that the US was watching Chinese currency movements very closely.
Moving China’s currency centre-stage would be a risky move for both sides, not least because of the sensitivity of foreign exchange markets, which turn over $3trn every day. Politicising the exchange rate is liable to lead to much greater instability and volatility, both of which are liable to be corrosive of business confidence and investment flows.
There isn’t a lot of substance right now to the idea that China is engaged—or plans to engage—in a covert devaluation. For a start, the authorities remember well the turbulence unleashed in 2015-16, which culminated in capital flight and the haemorrhaging of nearly $1trn of prized currency reserves. They certainly don’t want to trigger another such episode. And to be fair, China has tried to distance itself from allegations that it might use the exchange rate as a tool in the trade war. It has been cosying up to the EU as a partner to stand against Trump's trade war, and it came out in support of the recently concluded EU-Japan free trade agreement. These are the actions of a country that looks as though it wants to avoid raising the bilateral intensity of the current dispute with the US.
All of that said, there is little doubt that the Chinese foreign exchange market is now in a place—around or close to CNY7 to the US dollar—where authorities will have to show their hand in terms of intervention soon, or allow the market to assume that China is, after all, trying to depreciate the CNY both to offset the effects of US tariffs on Chinese imports, and to hit back at Washington.
There is much speculation as to whether Xi’s China is prepared for Trump’s trade war, and whether it may have misjudged the US president’s determination to see it through. But what matters now is how China responds. I don’t think it wants to risk the instability that would come from deploying the exchange rate as a tool but we will soon know if politics or pragmatism is winning the argument.
