China holds an effective tool in its arsenal to counter Presidential-elect Donald J. Trump’s proposed imposition of new tariffs on Chinese goods: initiating a currency war. Although this action carries significant risks for both China and the United States, it can serve as an effective antidote against tariffs. By allowing their home currency, the renminbi, to depreciate against the dollar, China has a feasible solution to the possible challenges posed by tariffs.
Why would a devalued renminbi make a difference? It’s simple economics: a less expensive renminbi would render Chinese exports more affordable for international consumers, softening blow to China’s competitiveness that might ensue from Mr. Trump’s tariffs. This financial maneuver could even neutralize the impacts of an additional 10 percent tariff that the President-elect has promised to enforce on his inauguration day.
Mr. Trump’s trading strategy also involves imposing a hefty 25% tariff on goods imported from Canada and Mexico, whilst insisting these nations join China in restricting the flow of drugs into the United States. China, possessing a tight control over its currency through its central bank, could respond by tactically devaluing the renminbi. This move might give a boost to China’s robust export sector.
However, the purported benefits of such an action need to be balanced against potential long-term pitfalls. A devalued renminbi might set off alarm bells for the Chinese public, potentially deflating consumer confidence, which in turn could suppress spending and depress the stock market. Competing with recent measures undertaken by policymakers seeking to bolster a wobbly economy, a freefalling renminbi might counterintuitively exacerbate economic instability.
After a housing market meltdown that dwindled the savings of China’s middle earners, China’s central bank, the People’s Bank of China, is understandably cautious of precipitating such an abrupt fiscal shift. Khaking cognizance of Mr. Trump’s warnings, the Chinese embassy in Washington proposes the view that economic and trade cooperation between the US and China is reciprocal in nature – arguing that neither party stands to gain from a trade or tariff war.
It must also be noted that Chinese enterprises have made significant strides in fortifying their manufacturing capacity overseas in recent years, resulting in the establishment of factories that assemble parts from China into finished products for sale in the United States. This operational restructuring has allowed some firms to circumvent tariffs imposed by the United States.
Wang Shouwen, China’s leading international trade negotiator, has pledged unflagging support for the nation’s exporters. Despite previous imposition of tariffs in 2018 and 2019, Chinese exports to the United States have remained commendably resilient. This is due in part to Chinese companies smartly splitting their exports into smaller consignments to dodge tariffs or slip under the radar of customs officials.
China has also shown strategic foresight by rapidly boosting exports to Southeast Asia and Mexico, regions where goods are often processed and subsequently re-exported to the United States with minimal or no tariffs. The renminbi, it should be noted, is not the only currency that has weakened against the dollar since the election. The Mexican peso and Canadian dollar both plummeted following speculations about Mr. Trump’s potential tariffs.
Responsibility for setting daily exchange rates falls to the People’s Bank of China, which undertakes diligent buying and selling of currencies to maintain the renminbi within a stable range. Some observers in the foreign exchange markets speculate that state banks might be strategically selling dollars at present and making use of the proceeds to purchase renminbi in order to preserve the current exchange rate.
Such a strategy could see the renminbi reach roughly 8 to the dollar, an exchange level not witnessed since 2006. However, many analysts are doubtful that China would tolerate such a marked depreciation in the renminbi. According to them, a more likely scenario is a bottom limit in the region of 7.3 to 7.5 renminbi to the dollar.
Adding to this compelling debate, an official at the People’s Bank of China has assured the financial community that the central bank will ‘maintain the basic stability of the renminbi exchange rate at a reasonable equilibrium level.’ Currency policy is likely to feature prominently on the list of priorities for the newly-elected Trump administration, given that the prospective Treasury secretary is an experienced hedge fund manager with an expert knowledge of currency trading.
In the face of potential protectionist tariffs from Trump, China will be tempted to undermine the currency before the new administration takes over as a form of pre-emptive protection. However, a former Obama and Biden administration official who specializes in China’s currency policy has expressed doubts that China would take such dramatic action.