The trade war between China and the US has escalated to seemingly unmanageable levels. On August 5, the yuan slid past its critical psychological level of seven against the US dollar. The outrage from the US was palpable.
US President Donald Trump took to Twitter and called out the Chinese government. “China dropped the price of their currency to an almost historic low. It’s called “currency manipulation.” Are you listening Federal Reserve? This is a major violation which will greatly weaken China over time!” Trump said.
The US Treasury Department has also backed the US president’s claims. In its statement, the institution says that it will rope in the International Monetary Fund to curb the “unfair competitive advantage” Beijing was accruing with its actions.
The yuan has not been this low against the dollar since the 2008 economic crunch. The reaction of global markets to this occurrence has been violent. The US equities took a tumble, marking their worst day of trade in 2019. The bond markets took a massive hit too. Viewed as a reliable indicator of a recession, the three-month, as well as the 10-year yield curve, received the most significant dip seen since 2007.
The yuan has established that it is indeed a force to be reckoned with. Unlike other currencies, the Chinese currency is not freely traded. The Chinese central bank has its value pegged on the dollar. The People’s Bank of China fixes the rate of yuan, allowing a 2 percent fluctuating window.
In the past 11 years, the yuan has stayed within the confines of its regular mark. This is why the recent devaluation drove the markets into a panic and gained China a currency manipulator moniker from the US.
Nevertheless, some financial analysts feel that Washington has become judge, jury, and executioner in the ongoing trade war. They say that China does not deserve to be called a currency manipulator any more than the US does. The US has said that China devalues its currency to stay competitive in trade.
Other analysts say that the continued weakening of the yuan in the last few years has been done to make the currency more market-driven. To achieve this status, the currency needed to loosen control over the peg with the dollar.
In the past decade, the yuan has indeed gained a lot of strength, partly due to the pressure that comes with having its currency tied to the US dollar’s value. From 2005 to 2015, the yuan rose to levels that market fundamentals could not justify.
The currency appreciated against all significant currencies, including the dollar itself. This hurt Chinese exports as well the expansionary measures Beijing undertook to ward off an economic slowdown. China, therefore, needed a minor adjustment to manage what was a devalued US dollar.
The US dollar in the last decade has been enjoying its position as the reserve currency of the world. The treasury department increased its money supply, and US dollars were printed and exported to China as payment for cheap Chinese consumer goods.
As long as the yuan stayed with the US dollar, the US had an excellent strategy working for it. The US would keep purchasing treasury bonds to cover its massive debt. However, once the Red Dragon decided to go for a market-based valuation for the yuan matters took a different outlook.
China made a move at a convenient time, supporting its declining export market. Pleased with this move, the IMF made the yuan one of the world’s dominant reserve currencies. The US had also been pushing the Chinese government to loosen its hold on its currency. Washington, however, was not ready for a depreciating currency but rather an appreciating one.
The devaluation meant that there were now more outflows from China. The US has three significant determinants when it comes to checking currency manipulation. First, the accused country has to have a large trade surplus with it. Secondly, the manipulator has to have a significant overall current account excess and has to have intervened in the currency market actively. China, though, has only one of those determinants working against it. A large trade surplus with the US.
Economic data from a balanced international trade shows that the yuan is neither overvalued or undervalued. The International money fund has said that the yuan is priced reasonably. As far as sensible trading goes, China has the onus to keep its currency exchange rate balanced to maintain its global purchasing power viably. This will pave the way for the internationalization of the yuan.
A weakening yuan nonetheless signals a strengthened dollar. This means that US exports are more expensive, which adversely affects their demand. China exports, on the other hand, are cheaper and their demand heightens. This is the source of the accusations leveled by the US against China.
The Chinese are the world’s biggest consumer of commodities, including half of the planet’s metals output. A devalued currency implies that China will import less as its economy cools down. This is also a signal of weaker China. It is also the cause of the uproar seen in the commodities markets since the August 5 announcement.
The falling yuan has also adversely affected currencies that follow the prices of commodity exports such as the Asian currencies and the Russian Ruble. The Export-led economies with strong yields and stocks markets have also come under extreme pressure.
The weakening yuan nonetheless has been suitable for the gold market. Moreover, as the Federal Reserve also begins to lower its rates, the outlook could not be better for the gold market. Central banks will keep stocking up on gold to protect their currencies against a dipping yuan. The tense international currency market makes gold the perfect investment asset. Gold is unaffected by the turbulence, giving its holders a safe and stable investment.
The rising prices of gold is a clear indication that gold’s store of value characteristic is at play. In China, the Chinese will buy more gold to hedge against the further devaluing of their currency. The price of gold expressed in the Chinese currency will increase. Gold, therefore, has a lot of incentive to rally in this season.
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