China Opens New Front in Trade War, Rattling Global Markets

Source: By Alexandra Stevenson, Ana Swanson and Jeanna Smialek, New York Times • Posted: Tuesday, August 6, 2019

BEIJING — The trade war between the United States and China entered a more dangerous phase on Monday, one that could saddle the global financial system with new risks at an already turbulent time.

The People’s Bank of China, the country’s central bank, allowed its currency to weaken past the psychologically important point of 7 to the American dollar for the first time in more than a decade. In an unusually blunt statement, the bank blamed the currency fall on President Trump’s “unilateralism and trade protectionism measures and the imposition of increased tariffs on China.”

Mr. Trump’s decision to impose more tariffs on Sept. 1 also prompted Chinese enterprises to stop making new purchases of American agricultural products, according China’s state-run Xinhua News Agency, which called it a “serious violation” of an agreement reached in June between Mr. Trump and Chinese President Xi Jinping.

The moves signaled a new front in a year-long economic war as Beijing escalated the type of retaliation it was prepared to engage in as punishment for Mr. Trump’s trade policies.

The escalation shook world markets on Monday, as nervous investors looked for safe places to park their money. Wall Street was on pace for its worst day of the year, with the S&P 500 dropping more than 2 percent in early trading. Selling was especially heavy in the trade-sensitive technology, consumer discretionary and industrial sectors. Yields on United States Treasuries, which fall as prices rise, dropped as investors sought safety in government-backed bonds. Benchmark indexes in Asia and Europe also fell 1 to 2 percent.

The question now is whether Beijing will fully weaponize its currency, the renminbi, allowing it to significantly weaken in value versus the American dollar. Such a move could prompt further retaliation by the Trump administration, which has already warned China against manipulating its currency.

Mr. Trump on Monday criticized China’s move, saying in a tweet that “China dropped the price of their currency to an almost a historic low. It’s called ‘currency manipulation.’ Are you listening Federal Reserve? This is a major violation which will greatly weaken China over time!”

Over all, the renminbi weakened by around 1 percent against the dollar, a move that is not necessarily significant on its own. But the fact that Beijing allowed it to breach a level that was long considered a line in the sand indicated a new front in a trade war that has dragged on for more than a year.

China’s decision could force countries that compete with China to consider devaluing their own currencies, since a weaker currency can make goods cheaper to sell abroad. That could lead to a zero-sum spiral of devaluations that would damage global growth and lead to even more trade protectionism, threatening the world’s economic integration.

“It’s hugely significant as they are making a clear choice to do this,” said Michael Every, head of financial markets research in Asia for Rabobank, referring to China’s central bank. “This is going to escalate rapidly and badly.”

Countries with weaker currencies can enjoy big advantages when selling their goods somewhere else. It can help them cut prices or be more competitive than rivals in countries with strong currencies. Mr. Trump and a number of American lawmakers have long criticized China for taking that tack with its currency, something Beijing has consistently denied.

Mr. Trump has accused governments besides China — like the European Union — of weakening their currency and has increasingly suggested the United States engage in the same type of currency devaluation. He recently discussed intervening in currency markets to artificially weaken the United States dollar but his administration decided against the idea, Larry Kudlow, director of the National Economic Council, told reporters.

Another route to effectively weakening the dollar — lowering interest rates — is already underway but could be undermined by China’s move.

The Fed cut rates by a quarter point in July — something the president has been pushing for over the past year — but tariffs and dollar appreciation mean such moves add less juice to the economy.

That’s because tariffs reduce trading partners’ growth, raise the value of the dollar and cut into domestic inflation. That forces the Fed to lower interest rates by more than it would otherwise need to just to sustain the current pace of economic growth and price gains.

“The dollar has a very mechanical impact in the way the Fed thinks about its main policy lever,” said Neil Dutta, head of U.S. economics at Renaissance Macro Research. “By doing nothing, the Fed is de facto sanctioning a tightening in policy. They would need to lower rates just to keep pace.”

By allowing China’s currency to breach a level long seen as a line in the sand, Beijing may be suggesting it is doubling down on the trade war with the United States, or abandoning hope for a deal in the near term.
Bobby Yip/Reuters

Mr. Dutta thinks the fact that the Chinese yuan is weakening increases the likelihood that the Fed will cut rates by half a percentage point at its next meeting, in September.

China’s currency has a way to fall before it would be an effective weapon. But on Monday, Beijing hinted that it might be willing to go there. The central bank said it would keep the renminbi “fundamentally stable at a reasonable and balanced level.” But it did not specify what that level would be.

Experts saw the move as a deliberate threat from China’s top leaders, who would most likely have to give permission to the central bank to let its currency fall past such a symbolically fraught level.

“The currency is largely controlled by the P.B.O.C., but the P.B.O.C. does not have the independence to decide on its own the level of the renminbi,” said Michael Pettis, a professor of finance at the Guanghua School of Management at Peking University, referring to the central bank. “This was clearly a decision made higher up.”

Yi Gang, the central bank’s governor, attributed the move in the renminbi, or RMB, to market forces, adding that many currencies had depreciated against the dollar recently.

“I am confident that the RMB will continue to be a strong currency,” Mr. Yi said in an article published to the social media account of the central bank.

But the fact that Beijing allowed its currency to weaken and moved to suspend purchases of American farm products represented a significant turn of events.

Last week, Mr. Trump said he would impose 10 percent tariffs on another $300 billion worth of Chinese goods as punishment for Beijing’s failure to make large-scale purchases of American farm products, like soybeans.

Mr. Trump had agreed in June not to impose more tariffs after meeting with Mr. Xi and agreeing to restart trade talks. But Mr. Trump said he was moving ahead with the levies as of Sept. 1 as punishment for China’s failure to live up to its commitments, including buying more American agricultural products and stemming the flow of fentanyl into the United States.

On Monday, Beijing indicated those purchases would not be forthcoming anytime soon.

China’s official Xinhua News Agency cited the country’s economic planner, the National Development and Reform Commission, and the commerce ministry as saying that Chinese companies were suspending purchases of American agricultural products in response to the Trump administration’s plans to impose new tariffs on $300 billion in Chinese exports to the United States.

The report said that China had not ruled out imposing its own tariffs on newly purchased American agricultural imports and that the Chinese companies suspended their purchases.

The escalating trade war already threatens to end what had looked to be a modest global expansion. The American economy appears to be growing at a healthy clip and Europe is showing signs of renewal. But China’s growth has been hit by the trade war, which has compounded some of its homegrown problems. Other countries that depend on China’s voracious economic machine, such as Japan, have been hit as well.

If China devalues its currency even more, countries that compete in similar industries, like South Korea or the nations of Southeast Asia, could face pressure to devalue their own currencies. Such devaluation spirals can lead to higher inflation, pinched household spending and disruptive shifts of money across borders. They can also lead to more tariffs or other restrictive trade measures.

A significant devaluation could also hurt China itself. Many of its biggest and most indebted companies in sectors ranging from property to heavy industry have borrowed huge amounts oversees in American dollars. A weaker renminbi makes paying that debt back more expensive. It could also hurt companies that depend on commodities, such as oil, that are priced in dollars, and could spur wealthy Chinese to take their money out of the country.

For those reasons, devaluations make investors nervous. Four years ago, when China devalued its currency by a more drastic amount, a global market rout followed.

This time, the immediate threat is how Mr. Trump may respond.

A devaluation helps to blunt the cost of his tariffs. Mr. Trump’s latest threat of an additional 10 percent on $300 billion of Chinese imports a year would broadly have the same effect as a 1 to 1.5 percent appreciation of the renminbi against the dollar, estimated Professor Pettis of Peking University. To offset those tariffs, the professor added, China could allow its currency to depreciate by a similar level.

That might only lead to Mr. Trump putting more or higher tariffs on Chinese-made goods, which could prompt even more retaliation from Beijing, said Ned Rumpeltin, head of European currency strategy with TD Securities.

“I think that we are in a very much tit-for-tat situation,” he said.

Ana Swanson and Jeanna Smialek contributed reporting from Washington. Albee Zhang and Claire Fu contributed research.