Why China is losing the trade war against the United States

Atlantico: In the context of the trade war between China and the United States, the Middle Kingdom badured that it would not devalue its currency, a practice common in a trade war. How to explain this choice when the country was suspected more than once of using this ploy?

Michel Ruimy: Be aware that the exchange rate of the Chinese currency is quite illegible. Indeed, every morning, the central bank establishes administratively but … taking into account, in theory, market reactions!, A central rate – the official exchange rate – compared to a basket of currencies composed of dollars, euros and yen. This level can not vary by more than 2%, up or down. We can say that the price of the yuan is neither totally fixed nor totally floating, and that it is between two regimes unlike the US dollar or the euro, which are freely convertible on the foreign exchange market.

The authorities have long wanted the renminbi to be as close as possible to a "free" fluctuation because they aspire to have their currency recognized as a reserve currency, a way of to defeat the dominance of the dollar and the United States.

However, the yuan is a minor currency in international trade: it represents only a little less than 5% of transactions against 30% for the euro and 45% for the US dollar.

Since its peak in 2014, the renminbi has only retreated against the greenback. Losing 10% against the dollar since April, the Chinese currency has reached its lowest level in two years, offering leeway to exporters targeted by US tariffs that came into effect on July 6th. The United States believes that the yuan is already quite undervalued, especially since this decline feeds the specter of a currency war as the trade conflict bogs down. Because the monetary tool, used here on the downside, makes it possible to play on the attractiveness and the price competitiveness of the Chinese exports on the world markets … a fact very badly accepted on the part of its trading partners, in the first rank of which are the United States.

In this context, this statement may surprise. But, not that much. It could be a game of "liar poker" with markets that the Chinese authorities are customary … Because the depreciation of the yuan increases the cost of its imports and reduces household income in real terms. This would run counter to the authorities' efforts to boost domestic consumption, its new creed.

On the other hand, a devaluation can lead to capital flight out of China and lead to a fall in the Chinese currency stronger than expected. In recent years, the central bank has managed somehow to manage the decline in its currency at the price of interventions in the foreign exchange market by selling a portion of its stock of US government securities – Treasury bonds – and dollars to buy currencies like euros or even yuan.

Today, the advantage of a devalued currency for exporters would be more than compensated and annihilated by the financial instability and volatility generated by the fall of the renminbi. The purchases would have a limited effect on the parity of the yuan if other foreign and Chinese players (insurers, companies, banks …) have negative opinions vis-à-vis the evolution of the currency and therefore become sellers.

Therefore, the central bank has an interest in convincing them that it will not devalue and that it wants a decline in the yuan to buy, if necessary, without increasing its price. It already offers local businesses reimbursement of customs duties on goods imported from the United States. Moreover, China has sent a strong signal to international investors by announcing the easing of foreign ownership restrictions in some sectors.

Can we say that, in fact, China is losing the trade war with the United States?

It can not be said today in such a way categorical because we are entering a battle of intimidation and it is politically difficult for officials to give in to what the public will soon consider to be blackmail on the part of the United States. In a pinch, could we say that she lost a battle but not the war … pending the continuation.

Today, the only goal of China is, in any way, to dissuade Donald Trump from continuing to want to introduce tariffs.

Therefore, there is a risk, at first, of witness a lightening of the Chinese position on US Treasuries and its strengthening on the lower yielding European or Japanese debt. But again, there would likely be an appreciation of the yuan against the dollar, which would weaken the relative attractiveness of its exports.

In addition, China imports four times fewer products than it exports to the United States. By imposing tariffs, a country obtains no particular benefit if not a persuasive effect on trading partners. China will, in turn, put tariffs on agricultural products because US agriculture is an export sector and has significant political weight in the Senate. Then, it will probably be energy products. As part of a potential escalation, it could attack US multinational operations in China.

But, at the same time, one must also bear in mind that the risk of capital flight is very real. The last time China let the yuan weaken, between early 2014 and mid-2015, the period that ended with the abandonment of the dollar peg in favor of a basket of currencies, the Chinese have lost almost $ 1 billion in foreign currency reserves, which they have not yet recovered.

But if the trade war forces China to welcome more foreign investors and to comply with the rules of international trade, would it not be a way for China to solidify and sustain growth?

If the resolution of the conflict requires, in the future and to a certain extent, China to open its trade borders by welcoming more foreign investors, by accepting more goods, respecting intellectual property …, China, to look at it more closely, might find it advantageous. Indeed, this openness, both economic and political, could stimulate for a long time the Chinese economy and would mitigate internal social tensions under certain conditions.

First, the authorities must stay the course by focusing on domestic consumption and try to increase the current level. Because the savings rate, regardless of the age group, is very high, especially among the 30 – 50 years because of the lack of access to credit, both real estate and consumption. This dysfunction, however, should not last forever.

In addition, Chinese companies must be able to compete with foreign competitors by quickly closing their technological gap. This is already more or less the case because China is no longer just the factory of the world and the competition of Chinese firms is sharpening.

In attempting an badogy with Richard Nixon. At the time, when he came to China in 1972, he showed other countries the way forward for the end of the 20th century. Perhaps today we are witnessing with Donald Trump the same thing: a new form of trade with China for the 21st century.