Currency Wars?


The truth is that over the last three years, Beijing authorities have been intervening to keep the CNY from devaluing, because they want to avoid capital flight.

Sticks and stones...

In an historic move, the US Treasury has designated China as a currency manipulator, for the first time since 1994. It sounds serious, but it is essentially meaningless theatre for investors, as the US administration seeks to pile on pressure by prejudicing sentiment. It is telling that the US Treasury chose to use the 1988 Omnibus Trade and Competitiveness Act, which is looser than the 2015 Amendment, which stipulates three criteria, of which China only meets one. With the 1988 Act, all that is required is a ‘material’ current account surplus and a ‘significant’ bilateral trade surplus with the US.

Technically, this designation triggers a renegotiation of existing trade agreements and potentially a request for a review of China’s currency by the IMF. For China, this is meaningless because the renegotiation of trade relations is ongoing, and the country is already under the IMF Article IV surveillance process.

What does this mean for investors in the longer term?

For those who invested in the A-share market ahead of the G20 conference in the expectation of a resolution or a truce between Beijing and Washington, DC this is bad news. It’s also bad news for expectations of global economic growth, which affects all markets, even US equities.

Clearly, the US Treasury has become more politicised and, as evidenced by the recent threat to raise another 10% of tariffs on the remaining imports from China, the Trump administration wants to play ‘hardball’. Politically, this designation provides cover for the next round of tariffs, which will more directly hurt the US consumer, since they are physically paying the tariffs on the goods they buy. Children’s toys, furniture and electronic goods are expected to go up in price, to reflect the new tariffs.

This should be viewed as one more escalation in the existing deterioration of the relationship between Washington DC and Beijing, with all the risks that such a move implies. We appear to have crossed the line into what observers call “currency war”.

If facts mattered, this might not be happening. The truth is that over the last three years, Beijing authorities have been intervening to keep the CNY from devaluing, because they want to avoid capital flight. Over that period, currency analysts point to an overvaluation of the CNY over the USD. That overvaluation has been helpful to the US. I guess that once that latest threat of incremental tariffs came through, breaking the truce struck at the G20, Beijing decided to stop being helpful. Interestingly, todays official fixing was at 6.9683, higher than investors expected. In China’s playbook, that demonstrates restraint. However, Beijing is losing patience and is increasingly angry at Trump and the US threats – restraint may prove difficult to maintain with further provocations.

Perversely, the biggest driver of devaluation of the Chinese currency appears to be POTUS, by virtue of his persistent and explicit efforts to derail the Chinese economy. And the confrontation with China is possibly the only issue that enjoys bipartisan support across Congress and the Senate, so investors should dig in for the long haul!

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