Yesterday we talked about tariffs and Trump’s objective to rebalance global trade.
It’s about China, and the multi-decade economic war it has waged using its currency as a weapon. That’s led to a wealth transfer, from the West, to China. And that has led to a structurally fragile global economy.
That said, a weak yuan has been the go-to strategy for manipulating economic advantage, and the formula for its rise to global economic superpower status. And we should expect China to counter Trump’s tariffs by … weakening the yuan.
If we look back at 2016, in the seven weeks surrounding the election, the Chinese central bank made the largest seven week devaluation of the yuan in a decade — in anticipation of tariffs.
This time, for Trump 2.0, the yuan is already set around the weakest levels vs. the dollar since 2007.
And if history is our guide (from trade war 1.0), we should expect China to create some leverage in trade negotiations by threatening a big one-off currency devaluation.
What leverage would that create?
A sharp yuan devaluation would (very likely) trigger global financial market instability. A small one-off devaluation in 2015 sent global stock markets into a sharp fall, on the fear that a bigger Chinese currency devaluation was coming, which could have led to a global currency war, as export competitors devalued to stay competitive.
A currency devaluation threat from China could either 1) put pressure on Trump to negotiate more favorably to avoid a bigger economic fallout, or 2) it could embolden his effort to end China’s economic warfare — perhaps by rallying allies to coordinate sanctions (to put China in the penalty box). My bet would be on the latter.