Thursday, December 8, 2016

Trump’s Chinese Currency Manipulation

His tweets are driving the yuan down against the dollar.

By Review & Outlook
The Wall Street Journal
December 8, 2016

Donald Trump says he’ll declare soon after he takes office that China is a currency manipulator because it is devaluing the yuan against the dollar. He may want to rethink that. These days China is intervening in the capital markets to prevent the yuan from going into free fall. The currency is now close to an eight-year low, down 12% from its peak in January 2014.

One irony is that Mr. Trump is contributing to the yuan’s fall with his critical tweets about China, as traders see economic trouble ahead. The Chinese government has tried to slow the yuan’s fall by selling dollars—in essence manipulating the currency in the opposite direction of Mr. Trump’s accusation. As a result, China’s reserves have shrunk to $3.05 trillion in November from $3.99 trillion in June 2014.

Even Washington’s Peterson Institute, a weak-dollar outfit that has long accused China of keeping the yuan artificially low, now admits that the currency is overvalued and capital flight from China is a problem. Chinese companies and individuals are trying to move money out before the yuan falls further. Bank of America Merrill Lynch estimates that $113 billion left the country in the third quarter, up from $99 billion in the second.

Beijing has responded by tightening capital controls. Companies that could move $50 million without much fuss now face a cap of $5 million. Banks face increased scrutiny, and large overseas acquisitions have been put on hold. These measures will help stem the capital outflow, but the underlying problem is that China’s lending and investment spree since 2008 hurt competitiveness by creating overcapacity.

The prices that companies can charge for their products has fallen, driving up the real rate they pay on debt. Wages continue to rise because the workforce began to shrink in 2012. Company profits overall are stagnant, and many state firms are losing money.

Many governments in this predicament would depreciate their currencies quickly to gain a trade advantage. But China’s leaders know this would be self-defeating in an economy of its size. The weak global economy can’t absorb a surge in Chinese exports, and the political backlash could lead to a wave of protectionism.

Beijing also knows that China’s spectacular growth after 1994 was underpinned by a stable yuan, not a weak one. That stability encouraged China’s most productive citizens to invest at home, rather than stashing wealth abroad.

China responded to American political pressure in the 2000s by revaluing the yuan—from 8.28 to the dollar in 2005 to a peak of 6.03 in 2014. (It’s now 6.88.) But that arguably made the yuan overvalued, with speculators betting that the yuan would keep rising. Defending the yuan meant keeping interest rates artificially high, slowing domestic growth.

Hence Beijing’s preferred course of action since August 2015 has been to allow market forces to gradually erode the yuan’s value. As long as the pace is slow, traders can’t make enough of a profit on shorting the currency to cover their cost of borrowing. Slow devaluation is hard to pull off, and it can easily become a stampede.

China will face more pressure to devalue in the year ahead as the U.S. Federal Reserve raises interest rates and the dollar strengthens. Mr. Trump’s election is accelerating that reckoning, with the paradoxical effect of making the yuan even weaker. Stronger U.S. growth from Mr. Trump’s policies would also increase the demand for Chinese goods, and thus the U.S. trade deficit with China is likely to increase too. Domestic companies couldn’t possibly meet the demand for products if U.S. growth hits 3% or 4% a year.

All of this shows how complicated it will be for Mr. Trump to reset what has become an interdependent U.S.-China economic relationship. Mr. Trump can have faster U.S. growth or a smaller trade deficit, but he’s unlikely to have both during his Presidency. His choice Wednesday for U.S. Ambassador to China, Iowa Governor Terry Branstad, understands this and is an advocate of U.S.-China trade.

If Mr. Trump wants a new deal with China, our advice is to focus on negotiating a pact for stable exchange rates while aiming to change abusive Chinese practices against U.S. companies, such as intellectual-property theft, rather than slap a 45% tariff on Chinese goods. Meanwhile, if he keeps tweeting, the Chinese may accuse him of talking down the yuan.

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