The trade war between the United States and China could turn into an upcoming currency war – Quartz

While Donald Trump continues to step up his slap-happy approach on tariffs on Chinese products, China is running out of US products on which to collect rights in retaliation. But if China wants to continue its momentum, it has other options.

Unlike the US government, the Central Bank of China – the central bank run by the Chinese government – directly manages the value of its currency. The Chinese government has let the yuan weaken by around 4% against the US dollar last month, among the biggest drops in value of a month in its history. The fall of the yuan raised fears that China could "turn a trade war into a currency war," as Brad Setser, an economist at the Council on Foreign Relations, put it.

If Trump's antagonism is the goal, the depreciation is twofold. charm. As this will make Chinese exports cheaper – and therefore more competitive compared to US manufacturers -, the weakening of the yuan will dampen the shock of Trump's tariffs on the Chinese economy, all things being equal, and may completely eliminate the impact. Conversely, it will also make US products more expensive than China buys, further enhancing the effects of Chinese tariffs on US-made products.

But this strategy is not as easy to implement as it might seem. weakens the currency a little bit without driving the market to expect a sharp depreciation, "writes CFR's Setser." It is, in my opinion, feasible given the state of the balance of payments of the China – but that does not mean it would not be risky. "

The yuan is not freely traded on a world market.As with any managed currency, a major problem facing custodians of the yuan is the possibility of inciting a herd behavior that could dangerously destabilize the Chinese financial system.

Since Chinese exporters earn dollars (and other currencies) enough to do with this foreign money depends largely on what happens with the yuan.When a gradual decline in the yuan indicates that it is overvalued – that is to say that this market requires less yuan per dollarthan than the rate of current exchange reflects -, the Chinese exporters t any interest in keeping their cash in dollars. As this dynamic develops, it triggers capital outflows that can endanger the economy as a whole.

Capital flight is particularly devastating for countries that have borrowed heavily in foreign currency and do not have foreign exchange reserves to defend their value. speculators – as demonstrated by the Asian financial crisis of 1997. China does not have these worries; its external debt is under control and it has a little more than $ 3.1 trillion in official reserves (probably much more scattered elsewhere in the state-dominated financial system)

but especially when growth has been slow. Unstable air. It is nowadays in China-capital flow can still be dangerously disruptive. And thanks to the largest scale of foreign investment flows in Chinese equities and bonds, it is more vulnerable than in the last capital flight in 2015.

One way to thwart the momentary piecemeal revaluation that brings the currency closer to the market value. But even that is not infallible. Especially in this period of growing economic uncertainty, a strong devaluation is likely to mark a loss of confidence in the economy, triggering a panic chain reaction not only in China but, potentially, in global markets too. .

the Chinese government does not seem eager to drop the yuan significantly. He has always been in favor of preserving stability by buying and selling dollars to offset market movements, preventing the yuan from making big swings back and forth. A strong intentional devaluation would break the stable monetary regime that the PBoC has worked hard to build, noted Chen Long, an economist at research firm Gavekal, during a recent conference call. However, the PBoC has very little control over the value of the yuan. If the market expects China to suffer more from the trade war than the United States, the pressures on depreciation could strengthen, Chen said

. A sharp decline of the yuan against the dollar could trigger a chain reaction among other exporting countries to the United States. For example, a Chinese depreciation would put pressure on other Asian export-oriented countries so that they also let their currencies weaken for fear of losing market share for companies Chinese. Fortunately for the United States, many of these countries have plenty of reserves to fight these market forces. The question, however, is whether the United States could persuade them to spend them.

"The impact on such a Chinese depreciation on the United States would be limited if the United States could convince its allies in Asia to act to avoid following China's downward currency," Note Setser. "But they are not likely to do it if they think the United States has caused the Chinese devaluation by reckless commercial actions."