Three things to consider about Trump’s plan to brand China as a ‘currency manipulator’

Three things to consider about Trump’s plan to brand China as a ‘currency manipulator’

Last week China’s currency, the yuan, slid to the lowest point in eight years – trading at around 6.89 yuan to the dollar. The US dollar rallied after Donald Trump’s election victory, forcing the People’s Bank of China (PBOC) to lower the yuan’s reference rate for eleven consecutive trading days. This rate was beyond the 6.8 value the PBOC reassured investors it would strive to maintain, in June this year.

The yuan reacted badly to the US election result because Trump threatened to label China a currency manipulator when he enters office. To Trump, the yuan is excessively undervalued, as a result of China’s downward manipulation of that currency. Although America’s trade deficit with China is well-established and favours both countries’ respective economic arrangements, Trump contends that America cannot compete with China’s low costs. He threatened to impose a 45% tariff on consumer goods imported from China. This latter threat is clearly more alarming, for both countries, though many economists are hoping that pragmatism will ultimately prevail.

Trump’s view is an old-fashioned view, as Patrick Commins notes, is technically incorrect, according to the US Treasury Department’s criteria of currency manipulation. But if this label were to be implemented, how would it affect China’s economy?

Despite Trump’s views, Beijing has been supporting the yuan; left up to the market, the yuan would likely go down, not up. Yusho Cho notes that Chinese authorities limit foreign exchange by individuals to $50,000 a year per person. This has prevented investors from moving more substantial amounts of capital out of China, the risk of which has been magnified by Brexit. But people will be able to start dumping again in the New Year, and given Trump’s antagonism towards China, many experts believe this will happen. But amidst expectations for a weakened yuan, there are three things to consider.

Despite concerns, China’s economic fundamentals remain strong

Growth in 2015 was slow, although GDP for China still grew at 6.9%. 2015’s series of devaluations sparked concern among investors about dwindling growth rates and reduced market confidence in the yuan. The PBOC intervened by selling foreign-exchange reserve (forex reserves) to support China’s currency.

This same pattern has continued into 2016. Beijing has burned through $540 billion in the first three fiscal quarters – nearly 10% higher than during the same period last year. The country’s forex reserves have dwindled to their lowest level since March 2011, and this has put a huge downward pressure on the yuan.

Nevertheless, despite current market figures, another round of devaluations is highly unlikely. China has posted a 6.7% Q3 GDP growth – matching the World Bank’s expectations for China in 2016. China’s economic fundamentals remain strong, if having been affected by diminished expectations due to predictions for a ‘hard landing’. But the currency is unlikely to drop any more than it has recently. Should it do so, these strong GDP figures will cushion the blow.

Yuan internationalisation: Beijing’s ‘Trump card’

Regardless of the truth behind his assumptions, Trump’s actions may facilitate a shift towards a more transparent and liberal capital market in China. As Commins acknowledged, the yuan’s recent fall has ‘merely brought it closer to fair value after a period of excessive strength’. Commins quotes the US Treasury, which estimates that the yuan remains 21% stronger than the dollar since December 2005, and 38% stronger ‘on a real, trade‐weighted basis’.

To achieve its ambition of internationalising the yuan, the PBOC must accept that the currency is overdue a depreciation in value. Beijing has stated its commitment to alleviate monetary control, although such commitments are occurring at a much slower rate than economists would prefer. A more honestly valued yuan would make it more attractive to third parties. China’s vast trade surplus is oft-cited as the primary reason why Beijing will face difficulties in transforming the yuan into a popular reserve.

However, Trump’s victory may provide an unexpected boost for the yuan. His unpredictability and his clashes with US Federal Reserve Chair Janet Yellen may decrease the US dollar’s popularity as a reserve currency. At a time when faith in the dollar is undermined, there is potential for Beijing to turn this situation in its favour. Beijing is already showing signs of wanting to adopt a moral high ground, in its message to Trump, to adopt the right attitude on climate change. Chinese leaders may want to adopt the fiscal high ground too. What is certain is that it is too soon to declare, as Charles Hugh Smith did, that ‘nobody wants yuan anymore’.

Debt problems exceed yuan fears

In recent years, economic progress in China has stuttered due to the transition it is undergoing from an export-led economy to a consumption-driven economy. China has thus braced itself for slower growth in 2017, in order to accommodate this shift. The current pressure on the yuan is being caused by an unavoidable reduction in Chinese exports, as Chinese manufacturing loses its place to lower-cost neighbours.

China’s shift towards a consumption economy has created a dangerous mountain of credit-fuelled debt – recently highlighted by the International Monetary Fund (IMF). Unsustainable government spending and a housing bubble largely drive GDP growth. In September, a record amount of loans were handed out, mostly in the form of mortgages. Overleveraged consumers are certainly a cause for concern, and 20 cities have now imposed restrictions to curb property speculation this year.

Once the government starts to tighten these stimulus measures, lingering fears around a ‘hard landing’ could be resurrected. It is this, more than anything else, which could influence another market ‘panic’ in China. But even these concerns are overblown.

Going forward

Ahead of Trump’s inauguration, many twists and turns in fiscal and monetary policymaking are to be expected – particularly with the Federal Reserve interest hike imminent. Although Trump has shown signs of diverging from some of his campaign promises, he is unlikely to alter his stance on China.

But this will not spell disaster for Beijing. On the contrary, Trump’s failure to understand the markets may actually undermine confidence in the dollar as a reserve, whilst boosting the yuan’s relative popularity. Regardless, the real threat to China comes neither from Trump, nor from a depreciating yuan, but from an overreliance on credit-fuelled growth.

 

Categories: Asia Pacific, Economics

About Author

Alexander Macleod

Alex is a Manchester-based Analyst specializing in Southeast Asian political and security risk. He holds a PhD in Politics and Geography from the University of Newcastle, where he examined the role that online media play in promoting and sustaining Malaysia’s racialized political landscape during general elections. Alex also freelances as a social media manager for a digital marketing consultancy. He blogs at seaofrisk.wordpress.com/