Washington Insider: Currency Values and the US-China Trade War

Urban media is preoccupied with the pre-election posturing it sees just now -- especially the threats being swapped by the United States and China over increasingly punishing tariffs. The New York Times says also that the "world is watching to see whether Beijing turns to one of its most potent economic weapons -- its currency."China's currency, the renminbi, has gradually lost value since mid-April. This week it was at "its weakest point in a decade," the Times reports. If the currency weakens any further, it could fall below the "psychologically important" level of 7 renminbi to the dollar. The last time it took more than 7 renminbi to buy a dollar was in May 2008, as the world was slipping into a financial crisis.In the arsenal of trade disputes, currencies may be potent weapons, but they are blunt ones and can boomerang against those who use them.There is nothing particularly threatening about the number 7 itself, the Times says. The renminbi at 7.002 to the dollar is pretty similar to the currency at 6.998 to the dollar.Still, falling below the "7" threshold "would be significant symbolically." It would suggest China is prepared to let its currency weaken further still. That would give China's factory owners an advantage when they sell their goods in the United States. It would also undermine the tariffs the Trump administration has levied on more than $250 billion in Chinese-made products.The United States imposes tariffs of about 10% on a wide variety of Chinese goods that arrive at an American port. If the renminbi falls 10%, the tariff is essentially nullified.Some politicians in the United States and elsewhere have long argued that China manipulates its currency, even though Washington officials -- including in the Trump administration -- have stopped short of official accusations. In this case, many of the forces weakening the currency are beyond Beijing's immediate control.China's financial system is firmly controlled by the government, giving the country's leaders a great degree of control over how much the renminbi is worth. Officials set a daily benchmark rate for the renminbi and allow its value to move a smidgen above or below that level in currency markets. Chinese officials say each day's trading activity helps determine the value they set for the renminbi the next day, but they disclose few details about how that actually works.On Tuesday, Beijing set that guidepost at 6.9574, "just a hair's breadth stronger than 7." In the world of foreign exchange, a higher number means a weaker currency.Chinese traders are sending the message that renminbi should be worth less. The people and companies that hold the currency have become increasingly nervous about China's slowing economic growth, slumping stock market, fragile real estate market and seemingly intractable trade war with the United States. Inflation has begun to tick upward, and rising prices tend to make holding the relevant currency less attractive.There are other reasons. Since late July, Beijing has tried to prop up the economy by having the state-controlled banking sector increase lending, making money more available. That means even more renminbi in circulation, weakening the currency's value.While China hasn't raised interest rates, the Federal Reserve in Washington has. That makes it attractive for many people to sell their renminbi and buy dollars.Still, the Times thinks that Beijing is trying to keep the renminbi from falling too fast.China has a number of ways to bolster the currency's value. One option is to follow the U.S. Fed's example and raise interest rates, which would increase Chinese incentives to keep their money in China -- but also would raise the cost of borrowing in China, just as the economy is slowing.Or, Beijing could buy up its own currency instead.Thanks to the way it has managed its currency over the years, China has amassed the world's largest foreign exchange reserves -- a $3 trillion stash of money it keeps in dollars, euros, pounds, yen and other currencies. It now has begun to tap that stash. The most recent report by China's central bank showed a drop of almost $20 billion in foreign currency just during September."Selling almost $20 billion in a month won't break the bank," said Brad W. Setser, an economist at the Council on Foreign Relations in New York. "But it does indicate the direction of current market pressure." And, the Times says, that indicates "broader risks."Three years ago, as its economy slowed, China devalued the renminbi in part to give its factories a helping hand. The financial world was shocked. Markets plunged.A year later, China had spent more than $500 billion from its reserves in an effort to shore up the renminbi. It later tightened controls on the financial system to shut off many ways people used to get money out of the country.So, the Times notes that the international financial system is highly complex and difficult to assess. However, the key message is that should the trade war intensify, China may look to make more aggressive moves with its currency. History shows there can be a price to pay. Certainly, this is a development U.S. producers should watch closely as it evolves, Washington Insider believes.