The Threshold of 7 Yuan per Dollar has been Exceeded
Is China using the exchange rate as a tool to react to the increase in American tariffs?
Published by Luigi Bidoia. .Exchange rate Dollar Chinese yuan Trade war Weekly currency updates
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The week just ended opened with the depreciation, on August 5, of the Yuan. On Monday People's Bank of China (PBOC) set 1 the Yuan midpoint to 6.99, accepting that it actually exceeded the threshold of 7. During the day, the Chinese currency reached 7.04. In the following days the Yuan continued to weaken, closing the week at 7.06.
Trump's interpretation is that of an intentional act ("currency manipulation") by China, in response to the American tariff policy.
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!— Donald J. Trump (@realDonaldTrump) 5 agosto 2019
The relationship between trade war and Yuan depreciation has been widely analyzed in this magazine. See:
- US-China: the trade war saga (May 15, 2019);
- Chinese Yuan is gauging trade war tensions (May 17, 2019);
However, Trump's interpretation leaves some doubts, for the following reasons:
- devaluation is a much weaker instrument of international competition than duties. The devaluations increase the competitiveness of a country but also "import" inflation and transfer resources out of the country. The increase in duties generates more public resources that can be put back into the economy by reducing taxes or increasing transfers. The increase in duties is a strategy that can therefore be carried out much more aggressively than devaluation;
- the chronology of events that suggests that PBOC only anticipated values towards which the market would have gone anyway, maintaining the semblance of a monetary authority still able to set the exchange rate.
Understanding whether the Yuan devaluation is the main Chinese reaction to the American trade war is important for two reasons:
- to measure the medium-term exchange rate risk of the Yuan;
- to foresee the possible evolution of the ongoing trade war.
The chronology of recent events
- On 31 July, at the end of the 12th round of trade meetings between the US and China, held in Singapore, Trump announced via Twitter that on 1 September a 10% duty on 300 billion US imports from China will be applied.
- A few minutes after Trump's tweet, many emerging market currencies begin to depreciate. The first is the Mexican Peso, followed by the Brazilian Real and the South African Rand. Among these, the Chinese Yuan also shows a weakening.
- On July 31, the FED cuts rates by 25 basis points. This decision, read by many commentators as favorable to emerging economies, does not interrupt the weakening of their currencies, signaling the compactness of the forces that are driving the market towards their depreciation.
- In the following days more and more currencies are involved in the depreciation against the dollar. Only the refuge currencies (Swiss Franc and Yen), the strong currencies (Israeli Shekel and BahtThailand) and the Turkish Lira exception, resist the strength of the dollar.
- On August 5, the PBOC takes note of the direction of the market and the forces that are moving it and decides to devalue, bringing the midpoint of the exchange rate to 6.99
1) On a daily basis, the People's Bank of China sets a midpoint of the yuan/dollar exchange rate and then intervenes in various forms on the various markets to contain fluctuations in the effective exchange rate within a range of 2%. This mechanism is similar to the European Monetary System (EMS) which at the end of the last century anticipated the creation of the euro. Setting a central parity does not mean that the currency will keep those values. On 16 September 1992 the pound and lira were forced out of the EMS, because the system of European central banks was no longer able to intervene in the foreign exchange market to keep the pound and lira within the fixed band. In the presence of a high degree of freedom in capital movements, central banks may not have sufficient instruments to contract the direction of the market, if this is "compact" in its expectations.