China manipulates its currency, but not in the way the US says it does

Is China "weaponising" its currency? Not really. Or at least not yet.

Despite the US Treasury Department’s labelling of the country as a currency manipulator overnight – having declared as recently as May that, after more than six months of analysis, the People’s Bank of China hadn’t been manipulating the value of the renminbi – China doesn’t appear to have intervened to create the depreciation of the currency that occurred on Monday.

Indeed, it was the lack of intervention that saw the renminbi slide past the psychological threshold of seven renminbi to the US dollar and to its lowest level since the financial crisis that caused US Treasury to change its stance, and Donald Trump to tweet about "a major violation."

The People's Bank of China didn't intervene to stop the depreciation of the renminbi.Credit: Bloomberg

Contrary to the US accusations, in recent years the PBOC has intervened in the market for its currency, but not to depreciate it but rather to prop it up. If not for its actions, the renminbi would probably have fallen through that 7:1 threshold earlier this year.

So it was the absence of action from the PBOC that allowed the renminbi to fall against the US dollar on Monday. The decision to allow financial market gravity to prevail was deliberate.

It was China's response, along with a direction to its businesses not to buy US farm products, to Trump’s tweeted announcement last Thursday that the US would impose tariffs on the remaining $US300 billion ($440 billion) of China’s exports to the US.

The PBOC itself directly linked the depreciation to Trump’s "unilateralism and trade protectionism measures and the imposition of increased tariffs on China," while also saying it had the experience and capacity to keep the exchange rate stable at "a reasonable and balanced level".

While a weaker currency is rational, given that it would have traded lower earlier if not for the PBOC as China’s growth rate has slowed, China is unlikely to allow the renminbi to depreciate much further.

While it would make its exports more competitive and blunt the impact of the US tariffs, the experience from four years ago would still be at the forefront of Chinese authorities’ thinking.

In 2015, in response to sluggish growth, the PBOC devalued the renminbi by about three per cent. That triggered a sharemarket plunge and an exodus of capital. It took about $US1 trillion of China’s foreign currency reserves to stabilise the currency.

China's central bank would also be mindful that a significantly weaker renminbi would export deflation, with particularly harmful impacts on the rest of Asia and on the eurozone that could, in turn, rebound on China.

The eurozone is particularly vulnerable to an appreciation of the euro because its growth has been anaemic to the point where the European Central Bank is again considering extraordinary monetary policy measures.

Ironically, it has been Trump himself who has been contemplating currency manipulation.

Only last month he convened a meeting of his advisers to discuss how they might weaken the dollar, with the options including a simple "jaw-boning", or talking down its value, and/or the use of Treasury’s $US94 billion exchange stabilisation fund.

While the advisers talked him out of it, Trump declared later that he hadn’t said that he would not do something. He’s also urged the US Federal Reserve Board to lower US interest rates further, specifically to help lower the value of the dollar against the euro and renminbi.

Those kinds of actions by the US, if taken, would have repercussions, triggering a round of "competitive devaluations" that would almost inevitably result in all-out currency wars. Currency wars that would be destructive for a global economy that, thanks to Trump’s trade wars, is already looking increasingly fragile and vulnerable.

Tremors from China’s response to Trump’s latest round of tariffs signal how self-destructive the trade war is becoming.

Apart from the tens of billions of dollars being collected -- not from China as Trump mistakenly believes, but from US companies and consumers -- there is significant damage being done to America’s farm sector and those US companies with global supply chains.

Most disturbing is that neither Trump nor his more hawkish advisers appear to understand the consequences -- for the US and the rest of the world -- of what they are doing.

The US stock market has fallen about six per cent in less than a fortnight and the inversion of the US yield curve, with short term yields above the 10-year bond yield, has deepened. That’s a sign of concern about the outlook for the US economy.

Every post-war US recession in the past has been preceded by an inversion of the curve, although not every inversion is followed by a recession.

Trump started a trade war with China which damages both parties and from which, unless China is prepared to surrender to the US administration’s demands and demolish economic and political structures that have been central to its growth and stability, there is no exit.

He’s also laid the foundations for the opening of another front with Europe.

Global growth is faltering and US growth is also slowing.

There is no confidence a president and his advisers will back off. They don’t appear to understand trade and have conflated their misguided fixation with trade deficits with a crude attempt to stifle the development of a potential challenger to America's economic and geopolitical hegemony.

The US is steadily pushing the global economy towards an otherwise avoidable recession, if not something worse. Most disturbing is that neither Trump nor his more hawkish advisers appear to understand the consequences - for the US and the rest of the world - of what they are doing.