Currency War With China Dooms Trade Talks

President Donald Trump’s trade war with China is turning into a currency war—dooming prospects for any sort of trade agreement between Washington and Beijing and ratcheting up the likelihood of a global recession.

This week, in response to Trump’s abrupt decision to hike up tariffs on $300 billion worth of Chinese goods, Beijing briefly let its currency weaken, a natural, market-driven response to a big exporter facing additional hurdles to selling goods overseas. But by allowing the Chinese currency, or renminbi, to fall below the psychological threshold of 7 yuan to the U.S. dollar, Beijing crossed another psychological threshold: Trump’s.

Late Monday, the U.S. Treasury Department officially designated China a “currency manipulator,” the first time the United States has made such a move in 25 years.

The latest U.S. moves all but ensure that catatonic trade talks with China will lapse into a coma, probably until after next year’s presidential elections.

“The deal that was on the table a few months ago was too far for the Chinese. Why would something beyond that be acceptable now?” said Mark Sobel, a former U.S. Treasury official who is now a chairman at the Official Monetary and Financial Institutions Forum, a London-based think tank. “The Chinese will take the pain rather than caving to foreigners.”

The U.S. president himself suggested recently, even before his decision to hike up tariffs, that Beijing might wait until after the 2020 election to come to a deal.

Even though the move to designate China a currency manipulator was a campaign pledge that Trump had vowed to carry out on his first day in office, it was surprising for several reasons—not least of which was that the Treasury Department had determined as recently as May that China was not in fact manipulating its currency, as the International Monetary Fund (IMF) confirmed in July.

But the Treasury Department’s decision is even more puzzling. China in recent years has actively intervened in currency markets—but to prop up, not push down, the renminbi. For years, Beijing did artificially deflate the value of its currency to make exports more appealing but recently has done the exact opposite to avoid capital flight and shore up confidence in the economy.

The decision to label another country a currency manipulator is somewhat ironic for the Trump administration, which has embraced its own brand of state capitalism. Trump administration officials seek state-managed trade, especially in commodities; redistribute tax resources to favor politically favored groups like big farmers; subsidize favored sectors like coal; and aim to curtail the independence of the U.S. Federal Reserve. The Treasury Department’s official excuse for designating Beijing a currency manipulator is that Communist China did not intervene aggressively enough to stop market forces from pushing the renminbi down.

“The logic at Treasury is completely tortured,” Sobel said. “It’s hard to say someone is manipulating the currency when the currency goes down in response to market forces.”

The official U.S. designation of China as a currency manipulator also shows one of the U.S. hole cards in terms of financial leverage to be a hollow threat. By statute, the designation requires the two countries to hold talks—something both sides have done fruitlessly since last year. Treasury Secretary Steven Mnuchin also said he will talk to the IMF about China’s currency behavior—the same IMF that sees the renminbi as fairly valued. In other words, the drastic step of declaring China a currency manipulator—albeit on specious grounds—has no teeth.

Despite China’s recent willingness to let the renminbi slide to the lowest level in more than a decade, many experts don’t think that portends an open-ended currency war. In 2015, when China made moves to liberalize its currency, it led to capital flight and domestic stock market slumps.

“I don’t worry too much about weaponization of the currency,” said Rachel Ziemba of the Center for a New American Security.

Letting the currency slip below a crucial threshold was a warning shot, not a sign of what’s to come, she said. “China, for the last 15 years or so, never wanted to have a one-way bet on the yuan, and I don’t think that has changed.”

And while there are fears that China could sell off its hoard of U.S. Treasury bonds, that would probably be self-defeating.

The bigger fear is what the escalation of the U.S.-China trade war means for a global economy that already has all its engine lights flashing. GDP growth forecasts across the developed and developing worlds are being continually slashed. Debt levels, both corporate and personal, are at near-record levels. The yield curve on U.S. bonds—a measure of confidence in the near-term prospects for the economy—is negative, an indicator that in the past has always signaled a recession. It’s not just the United States—investors in Germany are snapping up debt with negative yields: They are paying the government for the privilege of hoarding its paper.

Ladling a sharper trade and currency war on top of that broth is not exactly calming.

“It’s obviously not very productive for the world economy. To the extent you ratchet up trade wars, you ratchet up uncertainty, and that hurts investment,” Sobel said.