Mr. Market Swoons as Trump Administration Escalates Trade War with China With “Currency Manipulator” Charge

It was hard to miss that Mr. Market had a bad day on Monday as a result of China setting the level of the renminbi about 1.5% lower, below 6.90, in response to the Trump Administration announcing plans to slap 10% tariffs on $300 billion of goods as of September 1, in addition to the $250 billion of goods subject to 25% tariffs in July. The effect of the September measure, if Trump follows through, is that virtually all of China’s exports to the US would be subject to tariffs.

The selloff continued overnight in Asia as the Administration designated China a currency manipulator after US market hours. The initial declines overseas stabilized after China nudged its currency a wee bit higher.

Business Insider’s recap of the Monday action as the Dow closed 760 points lower, which was merely the biggest fall since last December:

The escalation has spooked global markets, wiping between 2.9% and 3.5% from all major US indices and setting off a global sell-off. Overseas, 2.5% was slashed from the European FTSE, 1.8% from the German DAX and 2.2% from the French CAC.

The price of iron ore plunged 6.6% while the price of gold, seen as a safe haven during stock market volatility, jumping around 1.6% as investors flocked to it.

The Wall Street Journal on the market opening overseas:

In Tuesday morning trading in Asia, benchmark stock indexes in Japan, Australia and Hong Kong were among the major decliners with each falling more than 2%. China’s Shanghai Composite fell 1.9%, while South Korea’s Kospi declined 1.6%, all building on retreats the previous day….

Bond prices and gold rallied. The yield on U.S. 10-year Treasury notes fell 0.01 percentage point to 1.72% Tuesday, and government bonds in Australia, South Korea, Japan and China all rallied. Bond yields fall as prices rise. The Japanese yen, considered a haven currency, was little changed at 106.32 a dollar.

China’s central bank set the daily midpoint for onshore yuan trading at 6.9683, 0.7% weaker than the previous day but still stronger than 7. The People’s Bank of China also said it would issue 30 billion yuan ($4.25 billion) of central bank bills in Hong Kong—a move seen as limiting possible short selling of the currency.

The more freely traded offshore yuan strengthened 0.2% in Hong Kong to 7.0828, a day after it hit a record low. The onshore yuan was little changed against the greenback at 7.0476.

Financial analysts noted that the designation of China as a currency manipulator was largely symbolic, a message that the US was not backing down. However, it’s worth noting that despite the fact that the renminbi really was undervalued during the early years of the Obama Administration, Treasury always punted on its April-October reports to Congress on designating China, which ran a hard peg back then (it moved to what is often called a “dirty float”) as a currency manipulator.

It’s not clear that there is any good path to a de-escalation, much the less a resolution. On the one hand, Trump in his one role where he displays a high degree of competence, that of master troll, has played the game with China (and North Korea) of dialing up rhetoric and threats and then backing off. On the other hand, Trump’s trolling has already hurt some American exporters, such as farmers. And stock market investors don’t like being in the crossfire. Stock market performance has been one reason that Trump’s base has stuck doggedly with him. Recall that the median income of Trump voters was higher than the median for US households overall, and above the median for both Clinton and Sanders voters. Anecdotal data, such as focus group findings, suggest that higher income Trump voters have given him good marks above all for the gains in their portfolios during his time in office.

Conventional wisdom among China watchers has been that the Middle Kingdom could simply outlast Trump, that the famously patient Chinese would best the erratic US president who is operating (at best) based on his gut instincts rather than any strategy. But Trump does have one of the best people in his Administration leading the China trade effort, Robert Lighthizer, although with Trump one is never sure until leaks spill out whether Trump has overridden his advisers or not. From a 2018 post by Marshall Auerback:

In spite of the shift in prioritizing services over manufacturing, and the discarding of the old Cold War quid pro quo, there remained throughout successive administrations a broader philosophic agreement about the virtues of free trade as a benign end in and of itself, rather than a means to end. Under Donald Trump, and his trade representative, Robert Lighthizer, that has all changed. Trump has always viewed trade as a zero-sum game in which there is one clear winner and one clear loser. He tends to focus on bilateral trade relationships, as a means of establishing which countries are playing the U.S. for patsies. Trump has even resorted to taking out full-page ads in his favorite media adversaries, the Washington Post and New York Times, to signal his new aggressive, unilateralist approach on trade.

Similarly, Lighthizer, who has immersed himself for decades in the fine details of U.S. trade policy, is not averse to using “executive orders, diplomatic pressure, and legal measures like… Section 232 [of the Trade Expansion Act, which empowers the U.S. president to impose tariffs on national security grounds, as]… legitimate tools for unsettling existing arrangements and pushing partners to the negotiating table. Lighthizerism is no roadmap for retrenchment but a blueprint for recapturing what is seen as a lost edge for U.S. manufacturing on the world stage.” He has also been very dismissive of the prevailing “conventional wisdom ”that implicitly assumes trade liberalization in and of itself would induce countries like China “to become more and more Western in… [their] behavior—almost as if… [they] were merely a more exotic version of Canada.”

When you start from the premise that free trade in and of itself is not an unalloyed good, but part of an “America First” strategy to make American manufacturing great again, or even allow free trade considerations to be superseded by national security considerations, it almost invariably follows that trade negotiations will be less benign and more aggressively unilateral, even with so-called allies (as both Justin Trudeau—“that punk little kid running Canada”—and Angela Merkel are now learning). Moreover, the lowest possible cost considerations (the usual endgame in a trade negotiation) might well not represent the primary objective in the overarching framework of a new agreement with Trump. Trade policy under Trump is designed to revive U.S. manufacturing, so as (in the words of Reihan Salam) “to steer U.S. firms to build resilient supply chains based in the Americas, not in China’s industrial heartland.”

As readers may recognize, even though Lighthizer has a coherent point of view, the flaw is that getting manufacturing back in the US isn’t just a matter of making China a less attractive place to business via tariffs and other means, like changes in Federal contracting. The US has lost skills at the factory floor, direct supervisor, and plant manager level. Even with the US embracing industrial policy and backing it with Federal spending, revived US manufacturing would rely heavily on automation. Yes, it would also create some good jobs, but almost certainly not in the numbers lost to globalization. And that’s before you consider that even with our EPA standards being weakened, US voters would not welcome the sort of pollution that has been part and parcel of a fair bit of China’s manufacturing.

The fact is that if Trump were in a position to be bloody-minded, the US could inflict more pain on China than it would suffer. The early rounds of this spat saw China’s quarterly growth rate fall to its lowest level in a decade while overall US growth remained solid. There have been on the ground reports from China of other signs of weakness, like a serious slowdown in payments to suppliers.

More generally, China an economic glass jaw. Its growth has been more and more dependent on debt, private debt as well as provincial-level government debt. Many analysts have pointed out that those debt increases are becoming less and less productive in terms of how much GDP growth they generate. Steve Keen also identified China as vulnerable to a crash by virtue of its high (by emerging economy standards) debt levels in combination with its rapid growth. His models show that merely stopping the growth of debt would kick off a crisis. Businesses that are too financially stressed to pay their suppliers on time are not good candidates for increased borrowing.

Some have argued that China could depreciate its currency to offset the impact of tariffs. There are limits to that. First, a fall in the currency big enough to offset tariffs would be massively inflationary in China. China imports food and fuel. China has been working hard to reduce inflation (which a decade ago was much higher than now) because it was socially and therefore politically destabilizing. Second, the prospect of further weakening of the renminbi would encourage capital flight, when China recently tightened its capital controls to put a damper on that. And China has cause to be concerned. From a June article in MERICS:

The growth of the financial system has raised the volume of capital flowing in and out of the country to levels that make it difficult for authorities to react to shocks. In a piece for MERICS, Victor Shih (2017) calculated that if 10 percent of China’s money supply were moved abroad, the country’s foreign currency reserves would be used up.

Now the countervailing question is: how much political pain is Trump willing to suffer? Here the China bulls have a point: the same way that the US military has become casualty-averse, so too are US voters not willing to take short term pain for longer-term gain, particularly when the prospect of gain is awfully tenuous. And China views Trump’s goal of having China agree to measures that would reduce its US trade deficit by 50% was draconian and clearly designed to undermine its standing as the up-and-coming superpower.

Now there is an area where the US could score a quick win: intellectual property. Getting China to curb counterfeiting and theft of trade secrets would give Team Trump a success and allow them to back off on other demands. But how do you assure compliance from China? Even though its move towards a total surveillance society gives it unparalleled ability to find and punish cheaters, why should it provide anything more than compliance theater? They could take a page from Japanese bureaucrats: do the least important 40% slowly and make earnest noises as to why the part that counts is hard to do but they are working on it.

There was one perverse upside for China to the trade row and market reaction dominating the news: it displaced coverage of the massive general strike in Hong Kong. From Hong Kong’s Massive General Strike Protest Has Paralyzed the City in Vice:

Hong Kong’s embattled leader Carrie Lam warned that the city was on “the verge of a very dangerous situation” as a general strike and coordinated protests paralyzed the city Monday. As tensions boiled over, two cars drove through crowds of protesters, and an armed mob attacked demonstrators with wooden poles.

The city was plunged further into chaos as workers from across about 20 sectors, including the civil service, went on strike. Coordinated and simultaneous rallies were held in seven locations, shutting down transport links and spreading the protest movement to virtually every corner of the city.

Protesters occupied and barricaded key arterial roads and shut down metro lines. Workers from the aviation sector joined the strike, forcing the cancellation of more than 200 flights at the city’s busy international airport.

South China Morning Post provided live-blog style coverage in As it happened: tear gas, arrests and fights as chaos reigns across Hong Kong. If you do a Google site search on for “hong kong general strike” you will also find quite a few video clips.

The Chinese, contrary to expectations in some circles, held off from a military crackdown. By contrast, one is left wondering whether Trump’s China escalation was an impulsive reaction to widespread denunciations of his anti-immigrant talk in the wake of the El Paso mass shooting. But Trump may merely be an extreme creature of the times. Silicon Valley has fetishized moving fast and breaking things, and more specifically, having no regard for rules and regulations. Trump’s efforts to smash institutions, even ones that have served US interests like NATO and the WTO, are similar in spirit, though playing out in different arenas. Whether they recognize it or not, they act as heirs of the libertarian anarchism of Milton Friedman and Ayn Rand.

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  1. bruce

    China is our banker now in an interdependent relationship with us as their customer, which is the stronger hand. Sooner or later, Mr. Market is gonna take it in the shorts.

    1. TroyIA

      How is China our banker when we are a sovereign currency issuer? If we really need more dollars we just press a button on a computer and then we magically have more dollars.

      If anyone needs more dollars it is the Chinese because they are at risk of capital flight and draining foreign reserves.

  2. Godfree Roberts

    “China an economic glass jaw. Its growth has been more and more dependent on debt, private debt as well as provincial-level government debt. ”

    The latest BIS debt figures show nothing of the kind:
    Total credit to the non-financial sector (core debt) as % GDP US: 249. China: 255
    Total credit to households (core debt) as % GDP US: 77. China: 51

    Because its economy is growing three times faster than ours, and because its debt is entirely internal, China’s debt burden is 34% of ours.

    1. ObjectiveFunction

      So, you still believe China is growing at 6-7% a year? Consult Michael Pettis on this one (and they haven’t kicked him out of Beijing yet, so he is hardly a China basher and Trumpite running dog).

      Per S&P, local government debt in China remains a mystery, since so much of it is held off balance sheets.

    2. Oh


      “……..Its growth has been more and more dependent on debt, private debt as well as provincial-level government debt”. The it here can equally apply to the US.

      The stock market and real estate surge in the last 10 years can be fully attributed to debt.

    3. Yves Smith Post author

      China’s debt, as many commentators have pointed out, is extremely high for an emerging economy. A direct comparison to the US is not apposite. The fact that the debt ratios are as close as they are is a huge warning siren.

    4. ewmayer

      “Because its economy is growing three times faster than ours, and because its debt is entirely internal, China’s debt burden is 34% of ours.” — That’s some seriously counterfactual rubbish you’re peddling there … even if China GDP were actually growing 3x as fast – and in reality its GDP growth is probably around parity with the U.S. now, if not lower – China debt certainly didn’t start at 250% of GDP, which means that they had to grow themselves *into* that debt load, which means that debt growth was indeed fueling the go-go years for GDP growth. And that implies that China has no chance to grow itself out of that debt burden you attempt to magically erase without radical structural-economic reforms. Trump’s trade-warriordom may be hastening those, but they were inevitable – when debt growth is driving the party, at some point the music inevitably stops, and the longer the day od reckning is put of it, the more painful said reckoning will be. Trump’s bull-in-a-China-shop approach to trade may in fact perversely be doing China a favor, long-term, in forcing the reckoning upon them sooner rather than later.

      1. mikkka

        Trump’s bull-in-a-China-shop approach to trade may in fact perversely be doing China a favor, long-term, in forcing the reckoning upon them sooner rather than later.

        Agreed. In China, default rates on corporate debts are rocketing in last one year or two due to the bubble squeezzing action of the goverment. The economy is hurt but would surely be healthier than before.

  3. PlutoniumKun

    Regarding the last point on HK – Beijing is well aware of the implications -internally and externally – of a hard crackdown. From the history of Tiananmen, the senior levels took several weeks to ensure absolute internal consensus before they decided to take a hard line on the protestors. So I think its very likely they will take the long view with HK – they will see if it calms down naturally – and then pick off apparent ring leaders one by one. This is standard procedure in China (there are protests all the time in the provinces over one issue or another, Beijing is surprisingly tolerant of these so long as they don’t threaten to run out of control – they see them as a necessary release of anger). But if they do decide that a hard line is necessary, they will be very decisive and ruthless in carrying it out. Iff they do, that’s the end of HK as a semi-independent entity and I’m not sure Beijing wants that yet, its very useful economically and politically as it is.

    Its very hard to read how the Chinese will react to Trump, but there is little doubt that his actions are causing significant hurt to the economy at a delicate time – the debt load within the economy is huge and I think the Chinese leadership are well aware they need time to recalibrate the economy to become less export and investment oriented. They may well decide to concede something to Trump, taking the long view that a few lost battles don’t matter if you win the war. But I think the decision to devalue is an indicator that at least for now, they will take a hard line – they may be calculating that Trump will not want problems so close to an election.

    1. Oh

      Beijing needs to consult with Obama to learn how to break up these demonstrations. He may even do it for a fee.

    2. False Solace

      See yesterday’s Links. There are no ring leaders anymore, China already jailed them — many of whom had been elected to the legislature.

      From today’s Links, Channel News Asia says “the protests are largely leaderless and organised online through social media and messaging apps.”

      One wonders if China will take the step of disabling internet access.

    3. mikkka

      A prosperous HK depends on its uniqueness to China, both economically and politically. Words have been spread that the tarriffs in Shanghai FTZ will be totally eliminated in the near future. So Beijing IS taking action on HK.

  4. Darthbobber

    If there were but 2 players, Chinese pain might translate directly to US gain. But the fallback host country for those who might consider relocation from China is not the United States.

  5. Synoia

    What action’s of Trump’s force supply chains to build up in US or the Americas as opposed to “under the US’ Control”?

    The response to sanction China appears to move factories out of China, but not into the US.

    In addition are Tariffs not eventually paid by customers? in this case China’s US customers may be headquartered in the US, but what prevents third country “assembly?”

    Does Trump have some “Made in the USA” plan, or is the eventual goal for US Capital to control manufacturing, and not repatriate (some) jobs?

    “Made in the USA” is very different from “Controlled by the USA.”

  6. inode_buddha

    This is just asinine. You mean the TARP bailouts, etc weren’t currency manipulation? Trump opening his mouth exposes western hypocrisy for all to see. Of course the real reason why they hate us is because of our freedoms…

  7. ObjectiveFunction

    To Mme. Yves and team: terrific precis of the key moving parts in this piece, very quotable. Many thanks!

    The ancient role of the Triads in acting as deniable muscle for pretty much all Chinese institutions* has surfaced once again in the HK situation, which may be the Czechoslovakia 1938 of our times.

    So this history piece on their relationship with the CPC, PLA and SOEs might be of interest to the commentariat.

    Season to taste please, as it’s not footnoted, though I’ve seen some of it elsewhere in McCoy, Tuchman, et al. The core info is also consistent with my own limited dealings with PLA Inc. and its KMT counterparts.

    Further, I can’t vouch for the hosting LimaCharlie website, or the author, Gary K Busch; they seem ok at first glance, but by all means kill the links if they are haram).

    During Mao Tse-tung’s rule and the era of Sino-Soviet tensions, the military moved many of its factories inland in case of a possible attack on China…. After Mao’s death in 1976, the new leadership encouraged the military plants to begin exploring civilian uses for their products.

    The higher organizational levels of the PLA created trading companies like China Xinxing, China Poly and China Songhai to take advantage of the opening of China’s economy to the international market. They formed banks, holding companies and international trading companies like Everbright to market these goods worldwide. The PLA ran farms, factories, mines, hotels, brothels, paging and telephone companies and airlines, as well as major trading companies…. Even the lowest levels of the PLA set up production units….

    [The PLA army district also] issued permits to enter or leave [each] region; it controlled the communications network in the region; it had the trucks and other transport under its control; and it was charged with maintaining order.

    These burgeoning military corporations were aided in their efforts by the presence of the Triads, especially in the urban areas. While the military had the physical control of the region and the industries, the Triads had the seed capital and the local administrative, middle-management, people. The local civil administration had become enmeshed in the activities of the Triads and was able to operate corrupt enterprises without a reliance on the Chinese Communist cadres who were notionally in charge of the regions. Usually, they too became part of the corrupt enterprise….

    During 1968 and 1969, a large number of Red Guards were purged by the PLA and exiled to Guangzhou for re-education. Many escaped and travelled to Hong Kong after the death of Mao Tse-tung in 1975. Since the mid-1970s, the term ‘Big Circle Boys’ has been used explicitly to refer to criminal groups based in mainland China.

    * Of course, TPTB using da mob to variously stoke, purge or quash popular movements is by no means unique to China! I suspect Prof Hudson’s Sumerian temples had their tonsured goon squads enforcing the beer and silver debts, and the dynastic cancellations thereof.

  8. Tommy S.

    one quibble. Friedman and Rand have nothing to do with libertarian anarchism. As far as to the right almost you can get from it. Capitalist libertarians sure….but not socialist or anarchist libertarians by any stretch…

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