Trump’s China Problem Is That a Weak Yuan Is a Strong Weapon

"(Bloomberg Businessweek) -- President Donald Trump has bragged repeatedly, in tweets and press conferences, that China is absorbing the cost of U.S. tariffs on Chinese products. He said it again on Aug. 5, tweeting that “it is now even more obvious to everyone that Americans are not paying for the Tariffs—they are being paid for compliments of China, and the U.S. is taking in tens of Billions of Dollars!”.Trump happens to be wrong about this, but set that aside for a moment and focus on his desideratum. He seems to be saying that he wants Chinese companies to cut the prices they charge by an amount equal to the tariffs to keep their customers unaffected. In his beautiful vision, Chinese companies would bear the full cost of the tariffs. Add the federal government’s import tax onto the discounted China price, and you would get the best of all worlds: more revenue for the federal government, no harm to the American consumer, and a squeeze on the Chinese competition..To repeat, this is not what’s happened so far. Economic analyses have shown that American consumers are bearing almost all of the cost of the tariffs. That’s because Chinese exporters haven’t cut prices significantly—their profit margins were already thin, and they’ve had little or no room for discounts..What if China did exactly what Trump wants? Wouldn’t that make the president happy? Actually, no. Because China effectively cut prices on Aug. 5 by allowing its currency to weaken—and Trump is furious. The Treasury Department even took the extreme measure of officially labeling China a currency manipulator, echoing the president’s own language. While the designation doesn’t have much teeth, it’s likely to anger the Chinese and make a trade deal even harder to achieve..Scarily, the president doesn’t seem to have a clear idea of how foreign trade works or even what his ultimate objective is and how to achieve it. He’s dragged the U.S. into a trade and currency war that has no end in sight. Key U.S. stock indexes fell almost 3% on Aug. 5 after the yuan’s depreciation. “We did not enter this particular trade war with China with a clear plan for how to get out,” says Philip Levy, a member of President George W. Bush’s Council of Economic Advisers who’s now chief economist for freight forwarder Flexport. “The plan for how to get out seems to have been ‘We’ll threaten them, they’ll succumb, and then we’ll be happy.’ So far we haven’t seen anyone talk about what if they don’t succumb?”.Let’s unpack the yuan’s depreciation, which amounts to nearly 5% since April. Any goods priced in yuan have become cheaper in dollars. The yuan depreciation seems to meet Trump’s requirement of making tariffs painless to American consumers. By reducing the yuan’s buying power relative to the dollar’s, it makes the Chinese poorer and Americans richer. For Trump, though, this is highly problematic. The depreciation will make it easier for China to hang on to its market share in the U.S. As a result, Trump could fall short of his oft-stated goal of bringing factory jobs back to the U.S. on a massive scale..You start to see the problem for the president. He wants to shelter Americans from tariff-related price increases. But he also wants China to lose market share, which can only happen if Americans feel the pain of paying more for imports from China and consequently switch to buying American. Trump can’t have it both ways. “If he’s trying to encourage jobs and producing things here by taking away from other countries, the tariff could in principle do that, but it’s got to inflict pain upon somebody,” says Menzie Chinn, a professor of public affairs and economics at the University of Wisconsin at Madison..Treasury’s designation of China as a currency manipulator is another refusal to engage with reality. While China did unfairly suppress the value of its currency in the past to gain competitive advantage, in recent years it’s been doing the opposite: propping up the yuan against market forces that would drag it lower. The reason the yuan weakened on Aug. 5—crossing the threshold of 7 yuan to the dollar in onshore trading—is because China dialed back its support for the currency. In other words, it briefly stopped manipulating. And that’s precisely when Treasury chose to label it a manipulator..This is Through the Looking-Glass material. Treasury Secretary Steven Mnuchin “will engage with the International Monetary Fund to eliminate the unfair competitive advantage created by China’s latest actions,” the department said in an Aug. 5 statement. It’s hard to imagine that the IMF will go along..Trump is right that China has behaved badly on trade—for example, by shielding domestic companies from competition while forcing U.S. and other foreign companies to surrender their intellectual property as the price of admission. He’s also correct that previous U.S. presidents, Democrats and Republicans alike, haven’t pried many concessions out of the Chinese. The problem is that Trump’s slapdash, go-it-alone strategy with regard to China has made it harder, not easier, to accomplish a solid trade deal..At this point in the deepening conflict, Chinese President Xi Jinping can’t make big concessions to Trump, because he’d be perceived as knuckling under to a foreign aggressor. And Trump can’t bring other nations’ influence to bear, because he’s chosen to engage China directly rather than through the World Trade Organization. “It was a tremendous mistake on the part of the Trump administration to declare a trade war with China rather than take legitimate complaints to the WTO,” says Anne Krueger, a former World Bank chief economist who’s now a senior research professor at Johns Hopkins University..In April, Robert Staiger of Dartmouth College and Aaditya Mattoo of the World Bank released a working paper that they said was “at once more charitable and less forgiving” than mainstream assessments of recent U.S. trade actions. On the charitable side, they wrote that there’s a logic to the U.S. behavior: a switch from “rules-based” to “power-based” bargaining. On the less forgiving side, they argued that the new style will ultimately harm the U.S. by undermining other countries’ commitment to rules-based bargaining. “The result could be a period of China Hegemony,” they wrote..The most important number in the financial world for the next few weeks will be the dollar-yuan exchange rate. On Aug. 6 the People’s Bank of China took a step back from confrontation. It set its daily fixing for the yuan at under 7 to the dollar (the fewer yuan it takes to buy a dollar, the stronger the Chinese currency is). It also announced plans to sell yuan-denominated bonds in Hong Kong, which would soak up yuan held outside the country and make it harder for traders to borrow the currency to short it—i.e., bet on further declines..Nevertheless, traders are bracing for the possibility that the Chinese central bank could resume making way for a weaker yuan, which would help Chinese companies compete in global markets. PBOC Governor Yi Gang indicated as much in a Bloomberg News interview in early June when asked if there was a red line for the yuan. “I don’t think along this mathematical scale, any number is more important than other numbers,” he said. He also said “a little flexibility” in the yuan was good for the economy..Trump is right to worry about a weaker yuan. Even though it shields American consumers from higher prices, it makes American goods more expensive in China, hurting U.S. exporters. For China, a weak yuan can be a strong weapon. Trump might have been happier if China, rather than letting its currency fall, had simply cut prices, destroying profitability. But that was never a realistic scenario..While the trade war is turning out badly for almost all American exporters, it’s especially bad for farmers because China has halted purchases of U.S. farm goods in retaliation for Trump’s announcement of 10% tariffs on $300 billion worth of Chinese imports starting Sept. 1. Roger Johnson, president of the National Farmers Union, the second-largest general farm group, says Trump’s “strategy of constant escalation and antagonism” has “just made things worse.”.Given how badly trade talks with the U.S. have gone, the Chinese have little to lose by letting the yuan slide, says Tom Orlik, chief economist for Bloomberg Economics. “It’s reasonable to assume that China’s decision-makers place a low probability on the chances of a win-win trade deal with the U.S. That means the political cost of a weaker yuan is reduced. Trump can rail against currency manipulation; China won’t pay much attention,” Orlik wrote on Aug. 5..The tightrope Xi and Yi walk is that allowing too little depreciation would hurt China’s competitiveness, while market expectations of a too-big depreciation could trigger an all-out currency crisis, with Chinese and foreign investors desperately evading controls to get money out of the country before it lost even more value. China had to spend almost $1 trillion buying yuan to defend it against a serious bout of capital flight in 2015..That China is suffering from the trade conflict with the U.S. appears to please Trump. “Thousands of companies are leaving,” he crowed in a July 15 tweet. But what’s bad for China isn’t necessarily good for the U.S. In a trade war, everybody loses. By ramping up trade conflict with China, Trump is leading the U.S. and the world into a place that he only dimly understands in pursuit of goals that he has trouble articulating. —With Shawn Donnan, Tian Chen, and Mike Dorning.To contact the editor responsible for this story: Howard Chua-Eoan at hchuaeoan@bloomberg.net.©2019 Bloomberg L.P."

Trump’s China Problem Is That a Weak Yuan Is a Strong Weapon

His tariffs lose potency in the face of a currency shift that favors Chinese exporters.

NDTV Profit

NDTV Profit

Follow Us

DOWNLOAD THE APP

Trump’s China Problem Is That a Weak Yuan Is a Strong Weapon

His tariffs lose potency in the face of a currency shift that favors Chinese exporters.

Choose a plan

Follow Us

DOWNLOAD THE APP