U.S. President Donald Trump had long threatened to call China out on its currency. But now that his administration has labelled China a "currency manipulator," there's little he can do about it. It's likely to rile Beijing more than anything, since China has been liberalizing its currency regime since 2005.
Indeed, the president caused the yuan to breach the level of C¥7.0 to the U.S. dollar. It had been heading that way, as I indicated in June, but the Chinese currency lost 1.4% and shot through C¥7.0 after Trump put 10% tariffs on the remaining US$300 billion in imported Chinese goods that didn't already have higher trade taxes on them.
The Chinese yuan dropped below C¥7.0 to the U.S. dollar on Monday. That night my time, U.S. Treasury Secretary Steve Mnuchin designated Beijing an official currency manipulator. It's a move Mnuchin, who is more dovish on China than many in the current administration, was no doubt nudged to make by his boss.
What next? The first step is for Mnuchin to take the issue up with the International Monetary Fund in order to prevent "unfair" competition from China. Just to get another lumbering international body involved, it's against the rules of the G20 group of 20 industrialized nations to use your currency for competitive devaluation.
In case anyone is wondering, the word "yuan" is akin to the yen in Japan or the won in South Korea. It means something similar to "dollar" or "peso," although in Chinese it literally means "round coin." It's been used as the term for the Chinese currency for centuries and got imported into Japan and Korea when they adopted the Chinese character for "round."
The term "renminbi" is a Communist invention, translating as "the people's currency." It came into being first in Communist-controlled parts of China in 1948 and then nationwide in 1949, when the "People's Republic of China" also began.
I prefer to use "yuan" rather than propaganda.
It's been awhile
Monday's move is the first time the United States has declared a nation a manipulator since 1994, when it declared China as such. The designation was enabled by a 1988 U.S. currency law, the outcome being to force the other party into currency talks. Back in 1988, the United States declared South Korea and Taiwan as currency manipulators as well.
The U.S. penalty is exclusion from government procurement contracts that China is currently highly unlikely to win. Since the United States and China are already engaged in official trade negotiation, and have been for more than two years, the "manipulator" tag serves little purpose.
There's been a fusillade of rhetorical return fire out of the Chinese capital following Trump's first salvo.
To call China a manipulator is "totally wrong," a headline on the official news service Xinhua blares. Xinhua quotes Chen Yulu, a deputy governor of China's central bank, the People's Bank of China, as saying that the move "violates the common sense of economics" as well as "international consensus."
The People's Bank of China in an online statement said the U.S. move is an "arbitrary unilateral and protectionist practice" that "seriously undermines international rules and will significantly impact the global economy and financial markets."
Going down 'the wrong path'
So, they don't like it. Chen warns that the United States better show "respect for the truth" and solve its trade disputes with China "before it goes too far on the wrong path."
We've been hearing a lot about heading down the "wrong path" and contradicting truth and history here in Hong Kong. Beijing doesn't like our hot-headed pro-democracy demonstrations at all, either.
The central banker, Chen, says China has never resorted to competitive devaluation and won't use its currency as a tool that way.
Actually, China was perfectly happy to have a weak yuan and manipulated it that way for decades while it was "factory to the world." But China is increasingly interested in shifting its economy into the service sector and has been upgrading its manufacturing into higher-margin products that are less susceptible to a currency discount.
Now may be the least-appropriate time to call China a currency manipulator. The central bank has long been struggling to keep China's currency stronger than it deserves.
Propping up the yuan
China's Big Four state-owned banks all have been actively buying the yuan since it broke through that C¥7.0 barrier. According to Reuters, they've bought yuan forwards and used swaps to sell the U.S. dollar in a bid to stall the yuan's slide.
Reuters quoted four "sources with knowledge of the matter" that the state banks have been swapping yuan for dollars. On Tuesday, they were all selling one-year onshore forward swaps, a trader at a foreign bank in Shanghai said, and that made the yuan strengthen in the afternoon.
The banks have also been restricting the supply of the U.S. dollar in Chinese financial markets because market participants have been using dollars to short the yuan. One state bank has also been active in offshore markets outside China to buy swaps and strengthen the yuan, Reuters reports.
Buying one-year forward swaps for the yuan is a bet that the yuan will have gained value against the U.S. dollar in one year's time. But if you place enough bets, they can be used to move markets now. Typically, the People's Bank of China has been using those swaps to control the speed with which the yuan changes in value but has not been using them to direct the value of the currency itself.
Besides generating good political capital with their moves, China's banks -- surely directed by the central bank and central authorities -- are also keen to stop a precipitous slide in the yuan. That would drive wealthy Chinese investors as well as Chinese companies to shift further currency out of China and the yuan, contributing to its weakness in a self-fulfilling prophecy.
A brief history
The yuan was trading at a pegged rate of C¥8.27 to the U.S. dollar until China began loosening its currency regime in July 2005. It then strengthened steadily for a decade, gaining 27.0% by early 2014, to C¥6.04 to the dollar.
This current spell of weakness began in April 2018, when the yuan was trading at C¥6.27. It has lost 12.4% since then, a short-lived spell of strength ending in April 2019. The yuan has consistently lost ground around the time that China "predicts" its growth for the year.
Premier Li Keqiang's statement that China would "target" growth of 6.0% to 6.5% in 2019, down from the target of "about 6.5%" in 2018, sent the currency south again this spring. China never misses. Growth was 6.6% last year, and will come in at 6.2% in 2019, according to Oxford Economics.
A slowing economy normally results in a weaker currency. That means the yuan's slide has been normal and based on economic fundamentals rather than any manipulated effort to boost exports. It is the strong U.S. dollar that has driven the yuan above C¥7.0 as much as anything on the Chinese side. Judged against other currencies, the yuan has not been losing ground.
Money talks, and so does Dollar
The impact of the currency-manipulator blow may be harsher elsewhere in the Asia-Pacific region than on China itself.
"You're going to pay the price for the trade war," the appropriately named David Dollar told The Australian Financial Review after the ASX 200 index in Sydney saw A$80 billion (US$54 billion) shaved off its value.
Dollar, a former U.S. Treasury diplomatic representative to China, said the trade war is contributing to China's slowdown, which will spill over into the developing world. Lower Chinese demand will also push down commodity prices, a major driver of the Australian economy.
Emerging-market currencies look vulnerable against the U.S. dollar for a variety of reasons. Expect weakness over the next six to 12 months thanks to slowing global growth, worsening exports out of Asia, trade tensions, and worsening interest-rate spreads. On Wednesday alone, three Asia-Pacific central banks - India, Thailand and New Zealand - cut interest rates, and most others in the region are doing the same.
Where is the yuan heading? It will likely not strengthen until there is some resolution to the trade talks, a reduction in U.S. tariffs, or another spontaneous driver of Chinese growth.
Chinese authorities are likely to do their level best to keep the yuan steady if not stronger. A likely scenario is for the yuan to trade between C¥7.0 and C¥7.25 over the next year or so.
Should the U.S. side intensify its tariffs or call off talks, it would "not be inconceivable," according to Société Générale's analysts, to see it head north of C¥7.50 or beyond.