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Is China Manipulating its currency? All indicators say otherwise

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China has long been accused of intentionally keeping its currency value low in an effort to make exports cheaper.

With the trade war now on between the US and China, many are wondering if China will return to its old strategy of aggressive currency manipulation.

Governments are often faced with the question of how much involvement is necessary. Therefore most governments of developing countries use a fixed, pegged or managed regime to ensure exchange rate stability.

Yet, does this necessarily justify currency manipulation? Intentional devaluation always leads to instability and a weaker currency.

Impact on the United States

Recent tax cuts intended to boost spending and the imposition of tariffs are among several factors causing rising inflation in the US economy at this time.

Inflation is usually combated with higher rates which leads to higher borrowing costs and a less competitive but stronger dollar.

While trade wars are sometimes good in theory, in practice they often only offer protectionism to specific industries, benefitting only a small section of the population.

In this case, the tariffs have been applied to raw material goods which will most likely have a greater impact on downstream sectors and create inflationary pressure.

The potential exists where all the benefits are captured by the producer and none are passed on to the consumer.

The trade war can, therefore, create greater volatility in the US dollar. The Fed’s proposed interest rate hikes can potentially impact the trend.

Impact on China

China’s economic conditions are already weak as the People’s Bank of China PBoC) cut reserve requirements twice in three months. However, attempts to increase liquidity are short term. Slowed economic growth is likely to cause a bearish market for the Yuan.

Expectations in relation to the trade war with the US will keep the Yuan under pressure.

While China has been known to keep its currency artificially low so exports will remain cheap, the country has been shifting away from this strategy recently due to issues with credit levels and intermittent inflation.

The PBoC recently lowered its reserve levels for the third time this year with expectations of further downward adjustments as the trade war progresses.

Since the Trump Administration’s announcements regarding the trade war in March this year, the Yuan has plummeted 6%. This, after the PBoC, reduced the reserve requirement by 50 basis points with expectations of this releasing $108 billion in liquidity.

So far, the United States has placed tariffs on $34 billion worth of goods and China has responded in kind.

The fear now is that China will use intentional weakening of the currency to combat its effects however, China can not afford a repeat of devaluation fears of 2015 and 2016 which led to a destabilizing level of capital flows to external real estate havens in Canada and Japan. The Chinese stock market is also already down by more than 20% and might not be able to withstand any threats to its real estate bubble.

Instead, China is attempting to inject cash on a large scale into the economy with the lowering of the reserve requirements and monetary easing with an unprecedented pumping of a $72 billion cash injection.

Nonetheless, the Chinese dollar is currently dropping.

In August 2015, the PBoC introduced a fixing mechanism to reduce the level of government involvement and increase market influences. However, this mandate was not always strictly adhered to, as a counter-cyclical measure was implemented in May 2017.

This was then removed earlier this year; therefore movements in the Yuan should mainly result from market movements. That this happens to be in the direction that Beijing prefers, some analysts aver, while beneficial is not intentional.

They also believe that the small market intervention recently implemented was to prevent the Yuan from sliding too far and sparking-off panic selling.

The United States is now threatening to place tariffs on $500 billion worth of Chinese imports, and China will not be able to retaliate in kind as their exports to the US totalled less than $130 billion last year.

Additionally, China’s foreign exchange reserves are now $3.1 trillion in comparison to its 2014 levels of $4 trillion. This means less leverage for use to defend the currency.

China’s ability to effectively use its currency as a tool to offset some of the impacts of the trade war is therefore questionable.

All in all, allegations of currency manipulation appear baseless. As the old adage goes, correlation does not mean causation ie although two events occur simultaneously or one occurs in relation to the other, it does not necessarily mean that one resulted in the other.

 

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  • Rob Siltaren

 

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