How The US-China Trade War Turned Into A Currency War

December 10, 2019

The trade war took a dangerous turn and
is now morphing into what many are calling a currency war. It’s all out economic warfare between
the two biggest economies in the world. U.S. and China. Two key developments took us here. The Chinese currency weakened passed
a significant level that investors were thinking maybe China would
defend—an indication perhaps that China was stepping up its fight
in the trade war. The U.S., in response, designated China a
currency manipulator, something that the U.S. Treasury hasn’t done since 1994. And while mostly symbolic, was seen as
a big aggressive move to call China out and just escalate this
trade tension even farther. What makes it difficult is that when
you have a currency war, everybody wants a weaker currency. Weaker currencies help your exports stay
more competitive on a world stage. But not everybody can
have a weaker currency. So in response to the U.S. and China’s moves on currencies, we
saw other central banks and economies take action like India, Thailand and
New Zealand, all surprising their markets through monetary policy and
all weakening their currencies. If everybody races to the bottom, it
can be very disruptive to markets and to the global economy. When the Treasury formally calls out
another country for being a currency manipulator. Not much happens. It’s largely symbolic. It’s a badge of dishonor. It’s considered embarrassing and puts that other
country at the top of the G-20 agenda for discussing what
it’s doing with its currency. In practice, not
much explicitly happens. The Treasury engages the International
Monetary Fund and China in negotiations and discussions about what
the currency has actually been doing and how they’re
going to fix it. However, this administration doesn’t necessarily
play by the same rulebook. So many are worried that by
designating China officially a currency manipulator, President Trump could use that
politically and on the world stage to just impose more tariffs,
other sanctions and other economic punishments. Now, that’s not necessarily in
the Treasury rulebook for how this goes. But we’ve seen President
Trump break the rules. Mostly everybody wants
a weaker currency. There are benefits to having
your currency be weak. Number one, it makes
your exports more competitive. If you’re Japan and selling Hondas and
Toyotas to Americans, it gives them an edge over companies
like GM and Ford. It also makes
earnings more competitive. S&P 500 earnings have gotten hit this
year because the dollar’s been so strong. Anybody that does business overseas, from
Apple to Procter and Gamble to the automakers to John Deere, which
President Trump also called out during a tweet, their earnings and their revenues
get cut by that strength of the dollar. They sell overseas. It’s less competitive. They bring the money back home. It’s worth less. We’ve learned this lesson
so many times. And that is currency wars and
tensions fueled by countries trying to weaken their currencies can have a
very destabilizing effect on growth and on stock markets. It happened in 2015. China made a surprise decision to let
its currency weak and devalue the yuan. Guess what? That led the S&P 500 into a
correction, 10 percent off the highs. That’s why as soon as we saw
China let its currency weakened, it sparked all sorts of concerns, not just about
the escalation of the trade fight, but about what’s really happening
beneath the surface in China. When countries devalue their currencies, it
leads investors to wonder, is their economy suffering
worse than expected? Are they going to have to deal
with capital flight, a scary prospect where people take money out
of their economy. We’re not talking about in a small
emerging market like Turkey, where we had these concerns. We’re talking about China, one of the
biggest markets in the world and the second biggest economy in the world. When you have other countries stepping in,
then to fight to protect their economies and their currencies, it’s this notion
of a race to the bottom on interest rates and on currencies. And that is what spooked markets. The fact that it’s going to be unpredictable,
it’s going to be a source of tension and ultimately it’s going to
kill growth because tensions put up walls between countries. Trade slows down. Tensions emerge. And that’s sort of been the theme of
what we’ve been seeing on trade and now currencies in 20 19.

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