Impasse as China-US economic relations take a turn for the worse

On August 1, in the wake of brief, unproductive trade talks, president Donald Trump announced a new round of tariffs. Chinese officials responded this week by forbidding Chinese firms from buying American agricultural products. Noting US protectionism and more tariffs hikes, the People’s Bank of China on Monday (Aug. 5) let the yuan depreciate and pass the psychological limit of 7 yuan per dollar. On Tuesday (Aug. 6) the US officially designated China as a “currency manipulator.” Global markets have reacted strongly to the increased uncertainty.

Trump unleashed the first round of punitive tariffs in the US-China trade war in July 2018. Since the start of June 2019, the US has applied additional 25 % tariffs to Chinese imports worth earlier about 250 billion dollars a year. The latest round of US tariff hikes, which go into effect on September 1, will add a 10 % tariff to all previously unaffected Chinese imports (worth earlier roughly 300 billion dollars a year). For its part, China has slapped (mostly 25 %) tariffs on American imports worth earlier about 110 billion dollars a year. US figures show that imports from China over the past 12 months were worth 509 billion dollars (down 4 % y-o-y), while US exports to China in the same period were worth 108 billion dollars (down 20 % y-o-y). The trade deficit, however, is about the same as a year earlier (400 billion dollars).

China’s decision on Monday (Aug. 5) to allow the yuan to depreciate to a level of 7.05 to the dollar hardly came as a surprise, especially with few other forms of direct reprisal available given the massive trade imbalance between the two countries. The yuan has not broken the 7-yuan line since spring 2008, so the psychological impact on markets was huge (even if the yuan’s drop was just 1.6 % from its Friday level). Besides the trade war, the downward pressure on the yuan’s exchange rate from the slowing Chinese economy and rising indebtedness made it easier for the government to allow the yuan to weaken. Depreciation is by no means a cure-all; it drives capital flight, which, if it worsens, could force the government to tighten already strict currency controls. It also hits private consumption.

The US has inexplicably chosen to label China a “currency manipulator” for the first time since 1994. The move is especially odd given that it is very likely the yuan would have fallen further if it was allowed to float freely. In any case, the label is fairly meaningless as the US, under its own legislation, must engage a “currency manipulator” nation in talks. The US and China have already been in trade talks for over a year and half.

Thus, the US and China find themselves at an impasse from which it is impossible for either side to extricate themselves with current approaches. Continuing down this road only increases uncertainty in the markets and reduces economic growth for all.