As US-China trade tensions have become trade skirmishes, and now threaten to become a trade war, most of the actions have been on tariffs and goods trade. China has countered US tariffs on solar panels, steel, aluminium, industrial equipment and medical devices with its own increased duties on soya beans and other foods, agricultural products, and automobiles.
The developing trade conflict has taken place in an environment of very strong US economic performance while Chinese growth has been slowing. It has also coincided with a depreciating renminbi exchange rate. After strengthening in the first three months of the year, the Chinese currency has become the worst-performing in Asia, falling by 7.7% against the dollar, and 5% alone from mid June to late July. ‘In China, their currency is falling like a rock,’ US President Donald Trump tweeted on 19 July.
From a market perspective, renminbi weakness is easy to explain. US interest rates are rising, the dollar has strengthened generally, and there have been concerns about slowing growth and rising defaults within China. But renminbi depreciation has led to concerns that this is taking place with People’s Bank of China encouragement and that China may ‘weaponise’ its exchange rate, opening up a new front in the trade conflict.
Yi Gang, governor of the People’s Bank of China, responded on 3 July by repeating the central bank’s long-standing policy that China will ‘keep the exchange rate basically stable at a reasonable and balanced level.’
The renminbi has continued to weaken during July, but forebodings of a weaponised renminbi are misplaced. Markets may edge the renminbi exchange rate lower, possibly with PBoC acquiescence. But fall is very unlikely to come to push. For three reasons, China is very unlikely to actively weaken its exchange rate as an aggressive measure in a trade conflict with the US.
The first reason is that intentional renminbi depreciation has significant risks for domestic financial stability. Despite the PBoC’s gradual efforts to introduce greater flexibility and market determination, the foreign exchange market remains acutely sensitive to perceptions of what the PBoC wants the exchange rate to be.
This was illustrated by the central bank’s disastrous attempt to recalibrate exchange rate policy in August 2015, which led to a sharp depreciation and surge of capital flight from China. Even if China’s large foreign exchange reserves and capital controls could stem the tide, the authorities’ strong aversion to market turmoil and fear of loss of control over capital flight remain a strong discouragement to shifts in exchange rate policy.
If the trade conflict with the US intensified, this aversion would certainly grow. There would be a high premium on assuring the public and the markets that the Chinese economy is stable and the authorities are in control.
The second reason is that renminbi depreciation is a very blunt instrument. It affects all China’s trade partners, not just the US. In fact, China tends to target carefully its use of trade and investment policy for sanctions purposes. Examples are restrictions on Philippine bananas (related to a dispute over the South China Sea) or on Chinese operations of South Korea’s Lotte confectionary company (over deployment of the THAAD anti-missile defence system in South Korea). Not simply targeting the US, this year China has applied its retaliatory tariffs to products like soya beans from districts specifically with Republican congressmen and Republican support.
China’s recent cuts in its global tariffs on automobiles and automobile parts, along with an increase in tariffs on these products from the US, are another illustration of the government’s targeted approach. China faces a much larger direct trade exposure in the US market than the US does in China. However this should give little comfort to America, since Chinese authorities have ways to impose costs on the much larger operations of US firms in China. The measures include adverse or withheld administrative approvals, such as the one that scuttled chipmaker Qualcomm’s bid for the Dutch chipmaker NXP.
The third reason why China is likely to forgo currency as a trade weapon is that it would undercut China’s larger ambitions to exert global leadership and diminish US standing. Starting with President Xi Jinping’s Davos speech in 2016, the country has tried to establish China’s narrative as the preserver of open markets and the global architecture. During the trade dispute, China has sought to cast the US as the aggressor and China’s actions as a measured response. It has tried to court other countries affected by US actions, particularly the European Union.
Adoption of a ‘China first’ exchange rate depreciation would revive suspicions of China’s willingness to ‘game’ the international system. Still more important, it would risk squandering what China sees as its moment to claim the international stage.
Robert Dohner is a senior fellow at the Atlantic Council in Washington. He was previously Deputy Assistant Secretary for International Economic Analysis and Deputy Assistant Secretary for Asia at the US Treasury.