China: “All-out” Trade War

Published on August 7, 2019
SGH Insight
And in response Beijing has, for starters, yet to confirm it will stick to the agreed plan after the brief July meeting in Shanghai between US Trade Representative Robert Lighthizer, Treasury Secretary Steven Mnuchin, and Vice-Premier Liu He to hold low level discussions through August that would be followed by a meeting of the principals again in early September. While that may still end up the case — after all talking is better than not talking — expectations that these meetings will proceed have for now only been confirmed by the US side.
Market Validation
(Bloomberg 8/9/19 )

USTs Gain as Stocks Slip; Trump Says China Talks May Be Canceled

Treasuries underpinned as S&P500 futures drop to lows of the day after Trump says September talks with China could be canceled.
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Senior Chinese officials vociferously reject the notion that their actions constitute currency manipulation, a label slapped on them by the Trump administration last week, even, they say, according to any of the three criteria explicitly laid out by the US Treasury itself for such a designation.

** More to the point, Beijing has interpreted the decision by President Donald Trump to hit China with the FX manipulator designation, following the threat to impose a 10% tariff on the additional $300 billion of its exports to the US not already taxed, as a sign that the US has crossed the line and entered an “all-out” trade war. 

** And in response Beijing has, for starters, yet to confirm it will stick to the agreed plan after the brief July meeting in Shanghai between US Trade Representative Robert Lighthizer, Treasury Secretary Steven Mnuchin, and Vice-Premier Liu He to hold low level discussions through August that would be followed by a meeting of the principals again in early September. While that may still end up the case — after all talking is better than not talking — expectations that these meetings will proceed have for now only been confirmed by the US side. 

** More importantly, with regards to the currency, the People’s Bank of China has been instructed to continue to “let the markets determine the direction of the Renminbi rate, while closely monitoring capital outflows (or inflows)” but at the same time, officials suggest that it would not entirely be a bad development under the circumstances should the RMB trade weaker than 7.0000. Having entered an “all-out” trade war, the RMB they say could very well trade between 7.0000 and 7.3000 for the remainder of the year (of course, “driven by markets”).

** The thinking now in Beijing is that a break in the RMB below 7.000 would prove no disaster to China’s economy, but might provide a “profound lesson” for Trump, and that only when Trump feels that the US stock market “bubble” is going to break, and that American agricultural products will not be sold in China on any scale, will he then come to the table to “negotiate honestly and sign a fair trade agreement.”

** Because China’s financial market is not fully open and the RMB not fully convertible, the message from Beijing, for better or worse, will be that the PBoC is fully capable and confident it can ensure the basic stability of the domestic financial markets, especially the FX markets, in an all-out trade war. The PBoC will continue to pledge to maintain “adequate liquidity,” and would furthermore consider appropriately reducing the Reserve Requirement Ratio or, even, lowering the benchmark interest rates — if necessary.

** China’s leadership fully acknowledge that a trade war is bound to hurt both sides, but after the latest developments, they are digging in further to respond to US pressure through the inflicting of pressure back in return. Indeed, from what we understand, China’s former Premiers Zhu Rongji and Wen Jiabao are said to have expressed their support for President Xi and Premier Li Keqiang’s hardline policies in discussions last weekend in Beidaihe, including the tit-for-tat countermeasures against the United States, while agreeing it is a waste of time to negotiate with Trump until he has felt enough pain to come to the table “rationally,” to “strike a fair deal” with China.

** Both elders are reported also to have expressed their support for making the RMB more “flexible” with the belief that a drop below 7.000 will not harm China’s economy; for the nuclear option, if needed at some point, of US bond sales; for the decision to refrain from purchases of US agricultural products under the current circumstances on any large scale; and for the decision to support Chinese high-tech companies with greater financial resources (see SGH 8/5/19, “China: Beidaihe, Retaliation, and Trade War”).

** Finally, both leaders reinforced the need to prepare for the worst – a “decoupling” from US technology and companies – so that any Chinese company that relies heavily on US technology must either develop its own, or actively seek non-US partners.

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