U.S., China Slide Into Policy Vortex With No Easy Escape

(Bloomberg) --

President Donald Trump has reacted to China's move to let the yuan depreciate by branding Beijing a currency manipulator while also claiming China's foreign-exchange strategy means it's paying the cost of U.S. tariffs.

Break those two positions down, however, and it's easier to understand why the trade war is spooking markets. Clashing consequences are surfacing and a potentially ominous reinforcing cycle is forming.

Trump and those around him have been frustrated by China's response to his tariffs. By allowing its currency to depreciate through the symbolic 7-per-dollar mark on Monday, policy makers in China preemptively helped offset the cost of a 10% tariff he plans impose on some $300 billion in Chinese imports on Sept. 1.

Just as China's currency swings limit the impact of Trump's tariffs, they also feed into longstanding accusation that China guides its currency for an export advantage.

“China is intent on continuing to receive the hundreds of Billions of Dollars they have been taking from the U.S. with unfair trade practices and currency manipulation,” Trump tweeted on Monday.

Trump also argued that the slump in the yuan proved his point that China — not Americans — pays the real costs for his tariffs, an oft-discredited claim.

On Tuesday, markets stabilized as Beijing denied it's cheapening its currency. But the latest twists revealed a policy vortex with no easy escape: If increasing tariffs leads to Chinese depreciation, which yields complaints about tariff evasion and currency manipulation, it leads you back to more tariffs.

That's not a hypothetical. Trump's frustration with China's retaliation and past currency moves is what has led to every escalation so far in the trade war. A year ago, U.S. tariffs were in place on just $50 billion in goods from China. Now, some $250 billion in annual trade is covered by a 25% tariff.

Come Sept. 1, a 10% tariff will take effect on a further $300 billion in goods. Increasingly, though, that looks like it may not be the end of it.

Charting the Trade War

The U.S. Treasury is about five years too late with its currency manipulator designation for China, says Bloomberg Economics' Tom Orlik. The days of a hyper-active People's Bank of China intervening daily to prevent yuan appreciation are long gone. If anything, China's central bank is now intervening to prevent sharper yuan depreciation.

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