Has Trump underestimated China?

The ongoing US/China trade war has been a sore subject for emerging markets investors since it began in January 2018, causing volatility and uncertainty in global stockmarkets. 

There are few markets which have escaped unscathed from the turmoil, both those in Asia and the US. 

Over the last 12 months to 30 August, the MSCI Emerging Markets index has lost 3.9% in US dollar terms while MSCI Asia Pacific has lost 4.8% and MSCI China has lost

5.1%, according to FE Analytics. In the US, the Dow Jones has remained largely flat over the last year with a rise of only 1.2% while the S&P 500 is up 1.8% over the same period.

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For US President Donald Trump, he is keen to reach an agreement with China ahead of his re-election campaign in November 2020 in order to appear successful to the electorate, having built his original presidential campaign around his skills as a ‘master negotiator’ in his business dealings. For communist China, this is not a problem for the President Xi Jinping, meaning they have minimal impetus to reach a deal within a certain period of time.

But, despite a December hiatus, it appears there is no resolution in sight between the two countries who are both unwilling to reach an agreement. Tariffs are currently imposed on both countries and a further 10% on $300 billion of Chinese goods was expected to be implemented on 1 September. 

Don Amstad, head of investment specialists APAC at Aberdeen Standard Investments, said: “People were very worried about the trade war last year but this year had generally been more positive. But recently that view has been called into question and much of the optimism has gone out of the market”.

CURRENCY WAR

The tension has hotted up in recent weeks with the handling of the Chinese renminbi, which fell below a critical level against the US dollar in August. 

At the start of month, the Chinese renminbi fell to below seven against the US dollar for the first time in over a decade, having last reached that point in March 2008. The seven number is seen as a significant marker as this level is not usually breached and the downward move could have been an early indicator of a sharper depreciation, which would have triggered a tightening of financial conditions for the US and emerging markets. 

This caused volatility in global stockmarkets as the ASX 200 fell by 2.4%, the US Dow Jones down 1.8% and the Hong Kong Hang Seng down 2.8%. In reaction, Trump tweeted that China was a currency manipulator and urged US Treasury Secretary Steven Mnuchin to engage with the International Monetary Fund (IMF) on the matter. 

The Treasury Department officially classifies a currency manipulator as a country that deliberately influences the exchange rate between their currency and the US dollar to gain unfair competitive advantage in international trade. A weaker renminbi would make Chinese exports more competitive or cheaper to buy with international currencies.

No country has officially been named as currency manipulator since 1994. 

Shane Oliver, chief economist at AMP Capital, said: “While the US will engage with the IMF, it is doubtful the IMF will back them as it recently concluded that the renminbi was around fair value. This won’t necessarily stop the US from using the label as a pre-text to take more measure against China though”.

In a statement, the Treasury Department said: “China has a long history of facilitating an undervalued currency through protracted, large-scale intervention in the foreign exchange market.

“China has taken concrete steps to devalue its currency while maintaining substantial foreign exchange reserves despite active use of such tools in the past.”

The People’s Bank of China (PBOC) defended the move and said the fall in the renminbi was driven by ‘unilateralism and trade protectionism measures and the imposition of tariff increases on China’. 

The decision by the Treasury to make a public statement symbolised a meaningful departure from the administration’s previous foreign exchange policy, said UBS head of macro asset allocation strategy Evan Brown. 

“The Treasury’s currency manipulation announcement is just part of a broader evolution in US dollar policy under the Trump administration. The President has verbally criticised China and Europe for competitive devaluations, demanded commitments not to devalue in trade agreements, and recently tasked aides to find ways to weaken the dollar. This is a meaningful departure from the implicit strong dollar policy or at least a laissez faire one that has governed US FX policy for 25 years. 

“The executive branch, via the Treasury Department, owns the right to intervene in foreign exchange markets. It is possible, especially in reaction to further dollar strength, that the President could authorise intervention to sell dollars against the offshore yuan, euro and yen. If the Fed were to act in concert with the Treasury, as it has done historically, the Treasury could sell about US$200 billion into foreign currency. Such a move would shift the dollar lower in a knee-jerk fashion, and the signal has the potential to carry a more pronounced depreciation.”

Nikko AM senior portfolio manager for multi-asset, Rob Samson, said: “The currency manipulation [accusation] was done by the US in the least-threatening way, it was more of a slap on the wrist and sounds more egregious than it was.”

This argument between the two nations subsequently led to fears the world was heading for a global currency war. But these are unfounded fears according to industry experts who say these threats are merely “hyperbole”.

Amstad said: “The ‘currency war’ is just hyperbole. China is like a teenager learning to drive with the keys to a Ferrari. They have made some errors but they have learned from these and their communication with the market is much better.

“If you list the criteria to be labelled a ‘currency manipulator’ then China ticks none of the boxes.

“A massive depreciation of the renminbi is unlikely as it would cause capital flight but currency can be used as a messaging device and Trump should see it as a warning.”

For China, a sharp depreciation of the renminbi would cause domestic outflows which could disrupt financial stability, at a time when China is trying to open up its markets to foreign investors. It would also make goods more expensive for Chinese consumers. 

Alex Treves, investment specialist for emerging markets at JP Morgan, said: “We don’t think China is a currency manipulator, you don’t have to look very far to find other countries which actually are manipulating their currencies whereas China’s was a managed move in the context of a strong US dollar. 

“We don’t think there is a currency war nor will there be one in the future.”

“It is ironic that the real concern to the US is lower renminbi and yet China’s intervention is actually aimed at limiting the renminbi’s fall which is a natural outworking of US tariffs on its exports,” Oliver said.

“As we saw in 2015, a falling renminbi is not good for emerging markets that compete with China and will put more downward pressure on their currencies which leads to renewed concerns about the US dollar debt servicing costs.”

NEXT STEPS

The divide between the two countries, both unwilling to reach a compromise, could lead to ‘mutually assured destruction’ commented Brown. 

The next steps from hereon, suggested by Brown, could include a full 25% tariff on all Chinese imports or restricting sales of semiconductors to a wide range of Chinese companies. From China’s side, it could impose limitations on the sale of rare earths to US companies or prevent certain US companies from operating or selling into China. 

“Any of the above steps would probably inflict meaningful pain not just on the receiving party but on the acting party itself. We view such escalation as unlikely while acknowledging the markets must place some risk premium that they will happen. Domestic political pressures not to back down are present on both sides, as are the risks of miscalculation.

“Our base case is that cooler minds prevail, now that the stakes have risen so high, the economic and political costs of further escalation on both sides are significantly larger than the benefits.”

Amstad said Trump had been ‘badly advised’ by those around him and was vastly underestimating China’s dominance in this trade war argument, to his detriment as he has so far been unable to secure a successful deal.

“China has been cautious to show its hand and its position is stronger than Trump realises. He has chosen to focus on traded goods between the US and China at the expense of everything else whereas China understands the relationship is more complex than this. They also have a lot more domestic policy options than Trump understands,” he commented.

“We are seeing the emperor has no clothes and the hollowness of Trump’s position is being exposed.”

He added Trump only had the power to negotiate a deal or impose tariffs on China as any formal deal would need to be approved by Congress. This could pose problems if Trump was not re-elected for a second term in November 2020. 

Samson, said: “We think getting a deal in 2020 is most realistic but there’s always the risk whether China will wait until the election is over. If Trump loses then a deal could be even later. 

“Regardless of which party wins the election, there is support from both sides so there will be a hard bargain to drive with China, though maybe a bit less than Trump had been pushing for.

“2018 was actually an unusually good time to put pressure on China as the economy was in a difficult shape after financial tightening so the fact it is still going on shows Trump may have underestimated China.”

As to when the trade war would be over, Eleanor Creagh, Australia market strategist at Saxo Capital Markets, said: “Addressing the trade deficit is just a sideshow for the ongoing decoupling of the Chinese and US economies. 

“We have always maintained that the tariffs and trade negotiations are just scratching the surface in a far deeper rift which is more akin to Cold War 2.0, and one that cannot be resolved in a ‘trade deal’. This is a long-running economic conflict and battle for tech dominance and hegemony, and the gloves are now off.

“Non-tariff retaliation measures from China are also a key risk from this point. China cannot match the US in dollar amount of imports to tariff so we could be looking at other non-tariff retaliatory measures from here. These include rare earth import restrictions, holding goods up in ports, license delays and stoking nationalistic sentiment to divert demand away from US goods.”

“China see Trump as an unreliable counterparty. Their big fear is that Trump either signs a deal and then goes back on it with one tweet, that he does not get re-elected or that he cannot get the deal through Congress,” added Amstad. 

“The level of anger in China towards US and Trump is rising, they want to see Trump hung out to dry.”