Why a weakening yuan is dragging the markets down.

4 min read
Why a weakening yuan is dragging the markets down.

Scarily, president Donald Trump doesn’t seem to have a clear idea of how foreign trade works or even what his ultimate objective is and how to achieve it. He’s dragged the U.S. into a trade and currency war that has no end in sight. Key U.S. stock indexes fell almost 3% on Aug. 5 after the yuan’s depreciation.

Let me explain, what actually happened in layman’s terms.

  1. Trade war (Continues..)
  2. Currency Manipulation

1. Trade war (Continues..)

On Aug 02, US President Donald Trump has said he will impose a fresh 10% tariff on another $300bn (£247bn) of Chinese goods, in a sharp escalation of a trade war between the two countries.

The US launched an investigation into Chinese trade policies in 2017. It imposed tariffs on billions of dollars worth of Chinese products last year, and Beijing retaliated in kind. Both countries agreed to halt new trade tariffs in December to allow for talks. But hope for a deal faded, and further tit-for-tat tariffs were imposed.

A truce agreed last December collapsed and in May the US raised tariffs on $200bn of Chinese products to 25% from 10%. Again China retaliated with tariff on $60bn of US goods.

Now, It’s China’s turn:

1. Currency Manipulation

For the first time in more than a decade, Beijing let the yuan weaken past the symbolically important level of 7 to the dollar on Monday.

It comes days after US President Donald Trump said he would impose a 10% tariff on $300bn ($246bn) worth of Chinese goods, effectively hitting all of China’s imports to the US with duties.

Q: What is the impact of a weaker yuan?

A: China’s economy depends significantly on its exported goods. By devaluating its currency, the Asian giant lowered the price of its exports and gained a competitive advantage in the international markets. A weaker currency also made China’s imports costlier, thus spurring the production of substitute products at home to aid the domestic industry.

President Donald Trump has bragged repeatedly, in tweets and press conferences, that China is absorbing the cost of U.S. tariffs on Chinese products.

Q: Why is currency manipulation so controversial?

A: Currency manipulation — by China or any other country — is seen to flout global trading rules by conferring unfair competitive advantages. The country does so by artificially inflating or deflating its exchange rate. It may be designed to make exports more competitive, to avoid inflation or reduce capital inflows.

Currency manipulation has “serious effects on the global market”.

Let’s unpack the yuan’s depreciation, which amounts to nearly 5% since April. Any goods priced in yuan have become cheaper in dollars. The yuan depreciation seems to meet Trump’s requirement of making tariffs painless to American consumers. By reducing the yuan’s buying power relative to the dollar’s, it makes the Chinese poorer and Americans richer. For Trump, though, this is highly problematic. The depreciation will make it easier for China to hang on to its market share in the U.S. As a result, Trump could fall short of his oft-stated goal of bringing factory jobs back to the U.S. on a massive scale.

The most important number in the financial world for the next few weeks will be the dollar-yuan exchange rate. On Aug. 6 the People’s Bank of China took a step back from confrontation. It set its daily fixing for the yuan at under 7 to the dollar (the fewer yuan it takes to buy a dollar, the stronger the Chinese currency is). It also announced plans to sell yuan-denominated bonds in Hong Kong, which would soak up yuan held outside the country and make it harder for traders to borrow the currency to short it — i.e., bet on further declines.

Trump is right to worry about a weaker yuan. Even though it shields American consumers from higher prices, it makes American goods more expensive in China, hurting U.S. exporters. For China, a weak yuan can be a strong weapon. Trump might have been happier if China, rather than letting its currency fall, had simply cut prices, destroying profitability. But that was never a realistic scenario.

While the trade war is turning out badly for almost all American exporters, it’s especially bad for farmers because China has halted purchases of U.S. farm goods in retaliation for Trump’s announcement of 10% tariffs on $300 billion worth of Chinese imports starting Sept.

Source: CNBC, Bloomberg, ET

Hope it was helpful and informative.

Akshay Seth

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