Counteracting Tariffs via Sinking Yuan: What Would It Take?

One of the ways China can counteract Trump tariffs is by letting the yuan sink. Let's explore how much.

Bloomberg reports Hawkish Fed, Weak Yuan Signal More Trouble Ahead for Emerging Markets.

If you thought the first half of the year was rocky for emerging market economies, brace for turbulence ahead with dollar strength and a weaker Chinese currency set to keep investors on edge.

The yuan has slid six percent against the dollar since June and analysts say if further losses materialize, accompanied by rising Treasury yields and greenback, that will be a volatile mix. Investors will be tempted to pull capital out of emerging economies across the board; policy makers around the region will be forced to raise rates in response. Already, India’s central bank governor Urjit Patel has warned of the risk of a brewing currency war.

In a note dated Aug. 1, Deutsche Bank AG said it expects the yuan to trade at 6.95 and 7.40 against the dollar by the end of 2018 and 2019 respectively, compared with a previous forecast of 6.80 and 7.20. It was around 6.83 on Thursday afternoon in Hong Kong.

Currency Manipulation Setup

That does not address the question asked, but it explains the setup nicely. And if the Yuan weakens substantially, Trump would press "currency manipulation" charges.

One way China could avoid those charges is if it floated the yuan. I suspect it would collapse, but we are all guessing.

What Would it Take to Counteract Tariffs?

That question came up in a series of Tweets today.

I asked: Robin, what is the math here. How do you figure? 7.20 is only another 4-5% away? Thanks Mish.

Chart From Robin

I understand what Robin is saying but I fail to understand the math. Regardless, lets assume it is true.

Look at the Deutsche Bank prediction of 7.40. That was for the end of 2019 but once again, everyone is guessing.

With that, let's review the three ways I mentioned that China could strike back.

Three Ways China Can Retaliate

  1. Let the Yuan slide 25% negating the tariffs.
  2. Further limit US firms ability to do deals in China
  3. Halt Rare Earth Exports. Rare earths are 17 minerals used to make cell phones, hybrid cars, weapons, flat-screen TVs, magnets, mercury-vapor lights, and camera lenses.

Option one has capital flight risks for China of course. But US tariffs pose numerous risks to the US and global economy as well.

Option two is a given.

Option three is rarely discussed, but China has at least 80% of the global market.

For further discussion, especially of the Rare Earth angle, please see US Trade Policy: Not Only are We Stupid, We are Hypocrites

Winning Ain't Easy

Winning ain't easy when everybody loses.

Mike "Mish" Shedlock

Comments (15)
No. 1-11
tz1
tz1

Bet against it. A million to Yuan.

Realist
Realist

Republicans bring in tax cuts to stimulate the economy. The Fed is forced to raise rates. Money flows into the US and the dollar goes up. Trump puts in tariffs and disrupts the global economy. Money flows to the US, as a safe haven. The dollar goes up. It’s the US that is causing the dollar to rise against other currencies.

AWC
AWC

Guess it’s time to acquire some Ag, Au and Pb, before tariffs are imposed on them?

Kinuachdrach
Kinuachdrach

Some advisors say that the Chinese oligarchs big fear is capital outflow -- and a declining Yuan would be likely to cause such an outflow.

For decades, China has had a privileged position in trade. (You could call it winning a one-sided trade war, if you wanted). They are not going to give up that privileged position and move towards genuine free trade voluntarily. All this ground-thumping is simply to move the Chinese leadership to the point at which they decide it is in their best interests to start negotiating. The prospect of a declining Yuan may be an important element in getting the Chinese oligarchs to the negotiating table. This is a long game.

caradoc-again
caradoc-again

Partially related, well worth a read. When population rolls back and gets older there's a scramble for trade. Link below with graphs. I reckon this is at the heart of trade sentiment.

"Those curious what the financial bubbles of  '01, '08, and present are about...it's the interest rate reaction and debt inducement tied to changing demographics and population growth.  Those curious about the current trade war and ongoing currency wars...again, these are all about a fight for what is now a shrinking global pie of consumers among those with the ability to consume.  The benefits of globalization have run their course and a rear guard action is now underway to maintain access to the shrinking first and second tier economies of the world.  This changing landscape must be part of the strategy for those seeking to maintain hard earned savings and wealth in a totally different environment than has previously existed in modern history."