Global markets were cheered last week by measures taken by the People’s Bank of China to reverse a precipitous two-month slide in the Yuan to a hair shy of the psychologically important 7.0000 US Dollar level. That rally was especially turbo-charged by the announcement on Friday of the reintroduction by the PBoC of a “counter-cyclical factor” used in setting the Yuan’s daily fixing level when the central bank’s goal is to push back on excessively one-sided currency moves.
In addition to helping stabilize FX markets and the roaring dollar that has been wreaking havoc on emerging markets, investors interpreted those measures to signal a de-escalation in the heated trade disputes with the Trump administration, which has made no bones of its displeasure at a weakening Yuan that has been offsetting the impact of US tariffs on Chinese exports.
But sources in Beijing characterize those FX stabilization measures in a different light entirely – especially on the heels of the lackluster, failed round of talks last week between US Treasury Undersecretary David Malpass and China’s Vice Minister of Commerce Wang Shouwen.
*** Chinese officials note the counter-cyclical fixing tool is used as an option to tweak and manage FX levels while avoiding actual intervention, showing China’s determination to keep making the case for the Yuan as a “free floating” currency. Indeed, the counter cyclical fixing tool can even help if needed to more tightly manage another round of depreciation of the currency, while avoiding sharp fluctuations, during a protracted trade war. ***
*** Attributing the 2% or so rebound of the Yuan off its lows largely to market forces, Chinese officials nevertheless expect the central parity rate of the CNY could now settle in the new, broad range of between 6.4500 and 6.9500 per USD for the remainder of 2018 – with a critical caveat that this outlook assumes the current economic situation remains more or less as it currently stands. ***
*** If, however, the US imposes 25% tariffs as threatened on the next $200 billion of Chinese exports, market forces, from what we understand, would be expected to push the CNY to depreciate again to the psychological level of 7.000. And were it to break that level, officials believe, it would be unlikely to trigger massive capital flows as experienced in the CNY depreciation of 2015. ***
*** As to the likelihood of that scenario, the delegation returning from last week’s talks in Washington reported back to the top negotiating leadership, and the report was not positive. From what we understand, China’s leadership now fully expects the Trump administration to follow through with its threat of tariffs on another $200 billion worth of Chinese exports – and to do so before the US November mid-term Congressional elections. ***
The New Normal
On Saturday, August 25, China’s powerful Vice-Premier Liu He was briefed in Zhongnanhai by Vice Minister of Commerce Wang Shouwen on the details of his just concluded two-day negotiations with US Treasury Undersecretary Malpass.
Despite the last minute lowered expectations, and polite characterizations of the talks as “constructive and frank,” Wang reported that the talks produced little to no progress of note at all, even behind the scenes, with not even a follow-up meeting planned as things stand.
And while still holding out hope for a de-escalation that could lead to a summit between President Xi Jinping and Donald Trump before the November US midterm elections (see SGH 8/7/18; “China: An August Trial Balloon”), Beijing is increasingly planning for the reality that this is not your regular trade war.
The US trade onslaught is, rather, now fully seen as a broader American campaign to weaken China in the great power competition between the two, a competition where friction on trade will be the “new normal” and, as such, remain an open case for the foreseeable future.
Even the immediate negotiations are expected to be long and bumpy, and, afraid that Trump could at any point rip up an agreement in hand, the Chinese leadership is approaching the negotiations with the greatest degree of caution – and skepticism. The premium, entirely, remains on movement at the head of state, summit level, while the entire monetary, fiscal, and political apparatus of China continues to dig in for the prolonged fight (see, most recently, SGH 8/17/18, “China: Beidaihe, US Trade, and Domestic Strategy”).
And the specter of the next, threatened $200 billion round of tariffs from Washington looms large. The comment period on the proposed tariffs ends September 6, with the tariffs going into effect towards the end of September or early October.
In anticipation of that, Beijing has telegraphed its eight counter measures, vowing they, and the pass-through of higher prices, will finally hit the US consumer back hard, as well as US companies that have sold more than $300 billion of goods last year into China.
In the meantime, the rules of engagement dictate the next round of talks should be held in China. And for what it’s worth, Chinese officials maintain they will neither offer a date nor offer the US side an invitation to Beijing for the next round of negotiations, that is, not unless the Trump administration takes that initiative again.