Currency Wars?

Currency Wars?

The U.S. Treasury has designated China as a currency manipulator. What does this mean for investors in the longer term?


Sticks and stones...

In an historic move, the U.S. Treasury has designated China as a currency manipulator, for the first time since 1994. It sounds serious, but it is essentially meaningless theatre for investors, as the U.S. administration seeks to pile on pressure by prejudicing sentiment. It is telling that the U.S. Treasury chose to use the 1988 Omnibus Trade and Competitiveness Act, which is looser than the 2015 Amendment, which stipulates three criteria, of which China only meets one. With the 1988 Act, all that is required is a ‘material’ current account surplus and a ‘significant’ bilateral trade surplus with the U.S.

Technically, this designation triggers a renegotiation of existing trade agreements and potentially a request for a review of China’s currency by the International Monetary Fund (IMF). For China, this is meaningless because the renegotiation of trade relations is ongoing, and the country is already under the IMF Article IV surveillance process.

Over the last three years, Beijing authorities have been intervening to keep the CNY from devaluing, because they want to avoid capital flight.
Kim Catechis

What does this mean for investors in the longer term?

For those who invested in the A-share market ahead of the G20 conference in the expectation of a resolution or a truce between Beijing and Washington, DC this is bad news. It’s also bad news for expectations of global economic growth, which affects all markets, even U.S. equities.

Clearly, the U.S. Treasury has become more politicised and, as evidenced by the recent threat to raise another 10% of tariffs on the remaining imports from China, the Trump administration wants to play ‘hardball’. Politically, this designation provides cover for the next round of tariffs, which will more directly hurt the U.S. consumer, since they are physically paying the tariffs on the goods they buy. Children’s toys, furniture and electronic goods are expected to go up in price, to reflect the new tariffs.

This should be viewed as one more escalation in the existing deterioration of the relationship between Washington, DC and Beijing, with all the risks that such a move implies. If facts mattered, this might not be happening. Over the last three years, Beijing authorities have been intervening to keep their currency, the yuan (CNY), from devaluing, because they want to avoid capital flight. Over that period, currency analysts point to an overvaluation of the CNY over the U.S. dollar (USD). That overvaluation has been helpful to the U.S. Interestingly, todays official fixing was at 6.9683 to the USD, higher than investors expected. In China’s playbook, that demonstrates restraint.

Perversely, the biggest driver of devaluation of the Chinese currency appears to be the President of the United States, by virtue of his persistent and explicit efforts to derail the Chinese economy. And the confrontation with China is possibly the only issue that enjoys bipartisan support across Congress and the Senate, so investors should dig in for the long haul!


Definitions:

China A-shares are the stock shares of mainland China-based companies that trade on the two Chinese stock exchanges, the Shanghai Stock Exchange (SSE) and the Shenzhen Stock Exchange (SZSE).

The Group of Twenty (also known as the G-20 or G20) is an international forum for the governments and central bank governors from 20 major economies. The members include 19 individual countries—Argentina, Australia, Brazil, Canada, China, France, Germany, India, Indonesia, Italy, Japan, Mexico, Russia, Saudi Arabia, South Africa, South Korea, Turkey, the United Kingdom and the United States—along with the European Union (EU). The EU is represented by the European Commission and by the European Central Bank.

The International Monetary Fund (IMF) is an international organization of various member countries, established to promote international monetary cooperation, exchange stability, and orderly exchange arrangements.

The 1988 Omnibus Trade and Competitiveness Act started as an amendment proposed by Rep. Dick Gephardt (D-MO) to order the Executive branch to thoroughly examine trade with countries that have large trade surpluses with the United States. If the trade surpluses continued, the offending country would be faced with a bilateral surplus-reduction requirement of 10%. Because of its style of zero-sum game thought, it is considered by economists to be a modern form of mercantilism. The act was signed into law by President Reagan, slightly less strict than proposed, as the Omnibus Foreign Trade and Competitiveness Act of 1988. It expired in 1991 and was not renewed until 1994 by President Bill Clinton. It again expired in 1997 and was renewed once more by Clinton in 1999.

The yuan is the name of China’s currency.

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