Patriotic parades showcasing Chinese power lack the country’s most potent weapon: its currency. Throughout the trade war with the US, China has mostly played nice on this front. New US tariffs, affecting $300bn of Chinese goods, put an end to this. The Chinese central bank has let the yuan fall below seven to the dollar. Investors must now guess how much pain China and the US will inflict on each other.
The US has designated China as a currency manipulator for the first time since 1994. This looks political. China met just one of the three US Treasury criteria of a currency manipulator. Even so, the US may impose penalties.
A weaker yuan should help Chinese business cope with US tariffs and a manufacturing slowdown. Exporters should be able to bolster weakening profit margins. Smartphone makers including Huawei — a US security bugbear — and Xiaomi are among the electronics groups that would benefit.
China has not actively sought to weaken the yuan so far. Over the past two decades, the yuan has priced stronger against its currency basket in more cases than not. A stronger yuan means more spending power for its companies and citizens overseas.
China will be reluctant to shift its stance permanently. Longer term, a weaker yuan would hurt confidence and trigger capital outflows.
Moreover, a weak yuan is bad for many other Chinese businesses. Corporates with large amounts of US dollar-denominated borrowings, such as Chinese airlines, would be exposed to higher debt service costs. China Southern Airlines, Air China and China Eastern have fallen more than 6 per cent in the past two trading days, underperforming broader markets that are already weak.
Those enterprises that import raw materials are also at risk. Shares of steelmakers such as Angang Steel and Baoshan Iron and Steel have continued their slide since Monday.
China cannot outgun the US on tariffs: exports to the US are more than double US imports to China. China has so far retaliated to US trade hostility with symmetrical force. Its use of the currency is true to that playbook.
That suggests China will pursue more aggressive devaluation only as US hostility deepens. That would skew trade in favour of China and against the US in countries that remain open to both. An old aphorism applies to both combatants: “Before you embark on a journey of revenge, dig two graves.”
Has the US entered a dangerous stage in its trade war with China? Or is this a largely symbolic move, and more posturing? The Lex team is interested in hearing more from readers. Please tell us what you think in the comments section below