China using currency to soften worst effects of trade war
If the renminbi had “cracked seven” — or po qi as falling through seven to the dollar is known in Chinese — in late 2016, it would have been a sign that Beijing was losing its grip on the carefully managed currency and possibly the world’s second-largest economy as well. But when that line was finally crossed on Monday morning, after flirting with it for almost three years, all was calm in Beijing.
It was no coincidence that the move came just days after US President Donald Trump threatened to impose punitive tariffs on all Chinese imports next month. Allowing the renminbi to crack seven is a carefully calculated gamble by the Chinese government that it can use the currency to ameliorate the worst effects of its ongoing trade war with the US without triggering capital flight.
The main difference between late 2016 and now is that three years ago Beijing was struggling to shore up domestic and international confidence in the renminbi, after a prolonged bout of market and currency turmoil.
But as bad as that turbulence was, strict capital controls imposed in late 2016 worked, stemming capital flight and keeping the country’s foreign exchange reserves above $3tn. The Chinese central bank also gained confidence in its ability, working in close conjunction with state-owned financial institutions, to steer the renminbi’s value in its most important offshore market — Hong Kong — as well as onshore.
The trade showdown between Mr Trump and his Chinese counterpart, Xi Jinping, has demonstrated Beijing’s ability to manage the currency.
After the US president first demonstrated his determination to pursue — and escalate — an unprecedented trade war with America’s principal geopolitical rival in the middle of 2018, the renminbi slowly but steadily declined from about 6.4 against the dollar to a low that year of 6.97.
This took some of the sting out of Mr Trump’s initial tariffs. But Beijing was also careful not to let the currency crack seven for fear of damaging the prospects of a trade deal with the US.
That pattern has held this year as well. At times when the two countries seemed to be nearing a deal, Beijing steered the renminbi towards a stronger exchange rate against the dollar. Yet whenever there were relapses, as occurred most dramatically in May, it weakened back down towards seven.
Its move through seven is a sign that Beijing now sees little hope of reaching a near-term trade settlement with the US. It is also a reminder to the US president that when it comes to managing China’s increasingly state-led economy in tumultuous times, Mr Xi has far more levers to pull than Mr Trump does in the US.