A quick note on China’s devaluation

August 5th, 2019 at 6:50 am

Source: WSJ

Just back from ranting about this on CNBC so I’ll quickly share some thoughts on the news that the Chinese yuan broke 7/$, in a depreciation that threatens trade-war escalation.

Bottom line: the trade war may be about to get worse, and that won’t be good for markets, consumers, and the global economy. It’s hard to see a way out between these two sides, though electoral politics could force Trump to stand down next year.

The numbers:

–Depreciations offset tariffs. That is, a 10% tariff, paid by importers and passed forward to consumers, is fully offset by a 10% depreciation. This is especially relevant in the case of Trump’s latest plan to place a 10% tariff on $300 billion more in Chinese goods, two-thirds of which are consumer goods (shoes, apparel, toys, cell phones). Earlier tranches have mostly been intermediate goods.

–The yuan depreciated over 1% relative to the dollar since last night and about 13% since its peak in March of 2018 (see figure above).

–Markets, which have been highly sensitive to the ups and downs of the Trump/China trade war, ain’t loving this; Dow futures are down about 300 points prior to today’s opening.

–If the market’s trade-related losses (which began last week) continue, it raises the question of the extent to which worsening financial conditions counteract the impact of last week’s Fed rate cut, and thus raises the likelihood of further cuts.

The trade politics:

–What’s freaking out the markets is their expectation that Team Trump will view this as an escalation. In fact, China’s central bank said the move was “due to the effects of unilateralist and trade-protectionist measures and the expectations for tariffs against China.”

–I share the market’s expectation. Trump obviously has more weighty, tragic issues to deal with today, but one thing he seems to understand is the role of currency movements in this fight and I expect him to hit back.

–The most obvious response would be to raise the 10% on the $300bn to match the 25% already in place on the rest of our imports from China.

–These dynamics aren’t pretty for China either. They have to worry about the impact of the devaluation on capital flight, an increasing problem in China. Also, since many Chinese firms borrow in dollars, this makes their debt service more expensive.

–Meanwhile, the whole damn trade war looks to be going badly from Trump’s perspective, predictably so as such wars tend to ding both imports and exports. In fact, in the most recent quarter, exports/GDP were close to a 10-year low and the trade deficit hasn’t improved at all on Trump’s watch.

–Is there any way out of this mess? The only thing I can think of is a political pressure valve. If the escalating trade war whacks US consumers through inflation and real growth channels, and does so close enough to the 2020 election, Trump could decide to dial his protectionism way back, and fast.

–As noted, markets are highly elastic to such whipsawing, and businesses have probably held back investments as well due to trade-war-induced uncertainty. So, the economic impact of some sort of resolution could be quite positive.

–Analysts at Goldman Sachs made an interesting point about this possibility. Suppose the Fed lowers more aggressively to offset any forthcoming escalation. Then, for electoral reasons, Trump suspends the war. The Fed will be reluctant to raise much in an election year, so GS argues this could pose an overheating threat.

–I’m inherently skeptical of arguments with a lot of links in their chain, and predictions of overheating have consistently been wrong. But worth watching.

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8 comments in reply to "A quick note on China’s devaluation"

  1. Kevin says:

    Jared,

    What do you think of this approach: The Market Access Charge to reduce the dollar’s overvaluation?

    https://www.washingtonpost.com/business/economy/trump-not-alone-in-seeking-lower-dollar-as-lawmakers-unveil-foreign-investor-tax/2019/07/30/90c18a40-b308-11e9-951e-de024209545d_story.html?utm_term=.a67af29df799

    Why do you think that the POTUS hasn’t embraced it? Or will he?


    • Jared Bernstein says:

      It’s interesting and has compelling attributes. BTW, M Pettis has a nice piece on it in Bloomberg Opinion. I’m not sure it should be at the Fed, and I would want it to be flexible. There are times when cap inflows are problematic and times when they’re not. But having a mechanism to push back on surplus countries exporting their excess savings our way could be useful.


      • Kevin says:

        Putting it at the Fed is a bit like installing your table saw in the powder room.

        Is the CBPP going to do an analysis?


      • Kevin says:

        Will the CBPP do an evaluation of the bill?


        • Jared Bernstein says:

          Doubt it, but I’ll speak to it in a forthcoming Vox piece. What’s your take?


          • Kevin says:

            I agree with you on the Fed angle.

            It’s not perfect, but perfectible. This is the first policy proposal that makes sense and would actually accomplish the goal of reducing or eliminating the U.S. current account deficit.

            I hope that some DC think tank will rise to the task and do an intelligent evaluation. The issue is too important.


  2. Bob Palmer says:

    ” Trade wars are good, and easy to win” – Donald Trump

    Who knew? This is a good example of what this seventy year old man knows to be true, but which isn’t. Because Trump doubles down when he is wrong, this problem with China will likely go on for a while. The challenge for China and the rest of us is how to end it without Trump looking like a “loser”. He will not tolerate that.


  3. Nick Estes says:

    You might want to point out to your readers that a downturn in demand would create the fiscal space for all countries (and the eurozone as a whole) to spend a lot more money on new green projects without raising taxes and without causing inflation. The downturn = a shortfall in demand that governments all over the world could fill with projects that desperately need to get done, like planting trees, weatherizing buildings and buiding more clean energy facilities and transportation. Governments can borrow the money to do this without causing inflation if the projected slack in demand materializes.


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