China shows its strength by allowing the renminbi to slide
Retaliation in the US-China trade war has taken a new form: the renminbi. Monday’s weakening of the Chinese currency past Rmb7 per dollar marks a decade low in the exchange rate and breaks through what is seen as a symbolic level. It is not, however, a sign of fatal weakness in the Chinese economy. Neither is it a fundamental shift in monetary policy. Coming just days after the US announced 10 per cent tariffs on the final $300bn imports from China, it is instead a clear sign that Beijing is prepared to use the currency as a weapon and let the trade war drag on.
The People’s Bank of China appeared well prepared for the moment the renminbi “cracked seven”. The Chinese central bank issued a statement pointing to protectionism and tariffs as a reason for the weaker currency. It highlighted that it “has the experience, confidence and capacity to keep the renminbi exchange rate fundamentally stable at a reasonable and balanced level”. This seems entirely fair. Currency weakness is the logical result of the step-up in the trade war. Moreover, China’s overall trade surplus has continued to expand this year — both with the US and other countries — despite the tariffs. The broader current account surplus has also started to increase again after years of decline. Most telling of all, foreign exchange reserves are stable at about $3tn, pointing to an absence of protracted capital outflows or significant pressure on the Chinese currency.
China’s economy, while slowing, has so far held up reasonably well from the trade spat. Trade flows have fallen, but the rotation towards a more consumption-oriented economy has lessened the impact from weaker trade on headline economic growth. And the gradual slowdown in gross domestic product growth is in line with continuing income convergence in the world’s second-largest economy. If China’s intention was a competitive devaluation to ignite export growth, this would need a much larger move in the currency. Against a trade-weighted basket of currencies, the renminbi has barely moved.
The slide past seven was nevertheless an important psychological barrier for markets. Emerging market currencies weakened in tandem on Monday and stock markets across the world dropped lower. As the uncertainty from the trade war drags on, it takes an increasing toll on the global economy.
Just as domestic considerations such as heightened Chinese nationalism limit China’s room for manoeuvre on trade, Beijing also risks local anger if the renminbi falls too fast. The PBoC will be wary of any destabilising impact that currency weakness could have on the local equity market or domestic companies with US dollar-denominated debt. A significantly cheaper Chinese currency would also — counterproductively — offset the impact of US duties on imports from China.
US president Donald Trump predictably responded by tweeting that Monday’s renminbi move was “currency manipulation”. Less than a fortnight ago Larry Kudlow, White House chief economic adviser, eased fears over a currency war by saying the US had decided against intervening to weaken the US dollar. But policy reversals under Mr Trump cannot be ruled out.
An exchange rate of Rmb7 to the US dollar does not hold any inherent economic significance for China and breaking through it will have limited economic impact. Any large sustained devaluation would, however, be destabilising for the entire global economy. China must consider the impact on its other trading partners, not just the US. The world already has a trade war, it does not need a currency war, too.