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China’s Currency Devaluation Triggers US Charge of Manipulation

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China’s Currency Devaluation Triggers US Charge of Manipulation

The designation carries no penalties, but it will have a ripple effect on China’s economy.

China’s Currency Devaluation Triggers US Charge of Manipulation
Credit: Pixabay

This week, China let its currency drop, crossing an important invisible threshold that now sees the Chinese yuan trading at more than 7 renminbi (or yuan) to the U.S. dollar, a low not seen since 2008.

The United States Treasury answered by using its power under the 1988 Omnibus Trade and Competitiveness Act of 1988 to designate China a currency manipulator.  The law specifically requires the Treasury to “consider whether countries manipulate the rate of exchange between their currency and the United States dollar for purposes of preventing effective balance of payments adjustments or gaining unfair competitive advantage in international trade.”

The designation of China as a “currency manipulator” has been bandied about on both sides of the American political aisle for years.  In a climate in which neither side of that aisle seems to agree on anything, the Trump administration’s move drew praise from none other than Senate Democratic leader Chuck Schumer, who was quoted on CNBC as saying, “China has been manipulating their currency long before and since President Trump took office. He should finally tell his Treasury Secretary to label China a currency manipulator.”

Trump did, and Secretary Steven Mnuchin followed suit.  The move represents one more campaign promise fulfilled for the Trump administration.

But the direct effect of the designation is weak. The U.S. must consult with the International Monetary Fund to attempt remedies. Actual penalties are unlikely.

What, then, is the real-world effect of the devaluation of the Chinese yuan, and the subsequent designation by the United States of China as a currency manipulator?

The little-talked about upside for American manufacturers and importers who sell in U.S. dollars but buy in Chinese yuan is that the extra cost of the duty they may pay to bring products in from China will be somewhat compensated for by the devaluation. Trump has said he may impose a 10 tariff on an additional $300 billion worth of Chinese imports into the United States starting in September.

But it is the effect on China’s import prices that could eventually be drastic. Imports are usually required to be paid in hard currency, more often than not in U.S. dollars. China has over 3 trillion U.S. dollars in reserve, but some analysts see those reserves as working capital rather than as a backup checking account for major purchases.

China, by manipulating (or allowing, according to the Chinese) its currency to drop, has just imposed a significant surcharge on everything it buys from the rest of the world. It’s possible that the yuan will continue to drop – whether by manipulation or by market forces – to a level of 7.5 to the U.S. dollar. At that rate, the yuan would have dropped 10 percent from its recent range around 6.8.

Does devaluation to counter the effect of U.S. tariffs justify the extra cost China faces in importing key components of its economic engine?

One of the largest risks China faces is an escalation of the price of crude oil. Crude, the engine that keeps the Chinese economy growing and performing, is clearly China’s most strategic import. As the world’s largest importer of crude, China more than 25 years ago gave up a long-held policy to remain self-sufficient in oil. A weakening yuan may send the price of imported crude up, threatening, perhaps like no other single commodity, inflationary pressure on the Chinese economy.

In addition, key components of China’s telecommunications industry are still imported, such as advanced microchips for the smartphone business. The costs for companies such as Huawei, embattled on many fronts, have just gone up, adding to its woes.

When Chinese ships pass through the Suez Canal to deliver their manufactured goods to Europe and the east coast of the United States, they pay hundreds of thousands of dollars to Egypt for the privilege. Those hard currency costs just went up, driving the cost of shipping out of China up, as well. The American consumer is therefore at risk of dealing with a double hit on purchases of products out of China: both the cost of the U.S.-imposed tariff itself, as well as the additional cost of shipping those goods to the United States in the first place.

Other key sectors are inevitably affected by a dropping yuan. The aviation sector, given the size of China’s aircraft purchases from abroad, may face higher costs in paying its contractual obligations to Boeing and Airbus. China imports food, including grains such as rice; this critical sector may be subject to increased costs. Imported raw materials that fuel the factories that China depends upon for its still export-driven economy will become more expensive.

The political cost to Xi Jinping will be felt not just domestically, but in his signature Belt and Road Initiative, as well. As reported in December 2018 in the Financial Times, China’s efforts to fund BRI projects in yuan have faltered to the point of failing, keeping dollars dominant in the settling of BRI costs.

“Given the renminbi’s limited scope as a global currency, contractors have typically preferred dollars in exchange for their work,” FT explained. “…To meet this demand, China has drawn billions from its massive $3tn-plus stock of foreign reserves …which help to finance various BRI projects…But China only has so many dollars.”

Quoting Citi’s David Lubin, the argument continues, “without an ‘infinite supply,’ the country ‘lacks an infinite capacity to meet its goals.’ What this means is that there is an imposed limit to what China can achieve with the BRI.”

The cost of the dual currency-related moves this week by both China and the United States far exceeds an increase in the price of goods in American stores. The cost may come to bear on the geopolitical goals of the Chinese leadership itself, particularly in the person of Xi Jinping. Xi now finds himself facing unprecedented pressures from his domestic economy, from an increasingly renegade Hong Kong, and from a man in the White House who may not be as much of a friend as Xi had counted on.