Defending exchange rate China’s top priority

Source:Global Times Published: 2019/5/19 18:33:39

Illustration: Xia Qing/GT

While the US-China trade talks haven't broken down, negotiations appear to have ground to a halt. It is said that the US is demanding China change some of its laws as part of the trade deal, which China believes crosses the line and will compromise the nation's "equality" and "dignity." Just as a commentary from the People's Daily said, "at no time will China forfeit the country's respect, and no one should expect China to swallow bitter fruit that harms its core interests."

At present, the two sides have reached important consensus on many aspects, but there remain three core concerns of China that must be addressed. 

The first is to remove all the additional tariffs, which must be totally revoked if the two sides are to reach a deal. The second is that the amount of purchases should be realistic. The two sides reached consensus on the volume in Argentina and should not change it spontaneously. The third is to improve the balance of the wording of the text. Every country has its dignity, and the text must be balanced.

The differences that touch the bottom line have plunged the negotiations between the US and China into great uncertainties. 

Considering the economic size of both China and the US, global capital markets jittered over the risk of a negotiation breakdown, with the Chinese market bearing the brunt. After Trump threatened to raise tariffs on May 5, China's A-share market fell by more than 5 percent on May 6.

Stock market plunges usually attract wide attention, but it should be pointed out that this is by no means the biggest threat to China under US pressure, nor is it the key risk the market should guard against. 

The biggest challenge facing China in the future comes from the exchange rate problem, and it is necessary to be prepared for the upcoming war defending the yuan exchange rate. It can even be said that no other problems are important compared with the exchange rate issue.

Compared with the tariff increase and reduced trade surplus in the trade sector, China's financial market is more vulnerable to US pressure. Instead of any substantial policy "weapon," the US only needs to issue verbal threats, which is enough to trigger turmoil in China's financial market. 

The most worrying issue is the yuan exchange rate. Once the yuan continues its depreciation against the dollar, it will trigger a series of chain reactions. Currency depreciation leads to asset price drops, which prompts capital flight overseas. Intensified capital flight will continue to weaken the yuan, which inevitably dents China's foreign reserves. If such a vicious cycle takes shape, it will have a broad impact on China's financial market, asset market and real economy.

The recent movement of the yuan exchange rate has somehow confirmed the above concerns.

It should be noted that even if the US and China could reach a deal in the future talks, the pressure and shadow of US-China tensions will persist in the Chinese market. The trade struggle between the two sides is only a small aspect of the extensive strategic competition between them. 

In addition to Trump's tariff threats, the US has implemented "strategic suppression" of China, from technology, investment and industry to finance, geo-economics and geopolitics. All these have been rooted in the US strategic adjustment toward China, taking the country as its "long-term strategic competitor."

Nevertheless, from the short-term perspective, there are both advantages and disadvantages in the depreciation of the yuan. On the one hand, this can be seen as China's countermeasure in trade frictions as the depreciation of the yuan will be conducive to Chinese exports, which will, to a certain extent, "hedge" the impact of US tariff increases on Chinese goods. That is why Trump doesn't want to see the depreciation of the yuan. 

But on the other side, the loss caused by the depreciation of the yuan will also be relatively big, which will lower the value of yuan-denominated assets and exacerbate capital flight. 

In particular, it will be detrimental to outward investment under the Belt and Road Initiative. In general, moderate depreciation of the yuan is a proper approach at present, with more advantages than disadvantages, but in the medium and long term, China needs to guard against the continuous depreciation of the yuan and the subsequent chain effects.

The article was compiled based on a report by Beijing-based private strategic think tank Anbound.

Posted in: INSIDER'S EYE

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