By Valentin Schmid
Immediately after Donald Trump became president-elect, the Chinese yuan fell through key support at 6.80 yuan per dollar, the lowest level since 2010.
The market reaction is hardly surprising, as Trump and his advisers have for a long time accused China of being an unfair trader and currency manipulator. They also vowed they would slap tariffs on Chinese goods if China doesn't play fair in trade.
Trump adviser Peter Navarro says China has an unfair advantage because it follows lower health and safety standards and uses slave labor to keep labor costs competitive.
"If we learned anything from the World Trade Organization and NAFTA, it is that you have to put in stringent rules for worker health and safety protection," he said, also mentioning China's export subsidies and currency manipulation.
According to Navarro, if China doesn't stop these practices, the United States will impose countervailing tariffs on Chinese products. Tariffs would result in fewer exports to the United States and therefore less demand for the Chinese currency.
"When Donald Trump talks about tariffs, they aren't the endgame. The goal is to use tariffs as a negotiating tool to stop cheating. But if the cheating does not stop, we will impose defensive tariffs," he said.
What Can Trump Do?
Victor Sperandeo, president and CEO of Alpha Financial Technologies LLC, thinks the United States could cap trade at a certain level, which "will harm China more than the United States. If we buy $500 billion, they have to buy $500 billion," he said in an email. The United States absorbed 20 percent of China's exports, worth $483 billion in 2015.
Other commentators think a Trump administration won't be able to implement very harsh protectionist policies at all, because the traditionally pro-trade Republican Congress would have to consent as well.
"Big tariff increases on Chinese imports are quite unlikely. The focus will instead be on the theft of American intellectual property-something most people in either party would probably agree is a serious problem," said Mark DeWeaver, author of "Animal Spirits With Chinese Characteristics."
Jim Nolt, professor of international relations at New York University, said that even if a Trump administration can pass draconian sanctions, China could selectively retaliate.
"China may act strategically by targeting sanctions against U.S. exporters located in the states or congressional districts of powerful Republicans in Congress," he said.
China could also hassle the American companies operating in the country, as it has done in the past, with anti-monopoly and other investigations.
Given these complicated details, a Trump administration will have to make some very good deals with China for its managed trade policy to work.
While export subsidies, sweatshops, and a lack of environmental standards are common in China, especially in industries like steel and solar, the issue of currency manipulation is not as clear-cut anymore as it was 10 years ago.
Up until 2005, China pegged its currency to the dollar at a rate of 8.27 yuan, despite enormous exports and capital inflows that would have warranted a much higher exchange rate. China kept the rate stable by buying Treasury securities to the tune of $4 trillion, thereby creating an artificial demand for dollars.
After pressure from the United States, China let the yuan rise to a high point of 6.05 yuan per dollar in early 2014. Since then, however, the rate has not really been in China's hands anymore.
Systemic economic problems and the creation of $35 trillion in bank credit, as well as regime leader Xi Jinping's anti-corruption campaign, have led to massive capital outflows, estimated to be between $1.2 trillion and $1.5 trillion since the beginning of 2014. These capital outflows were higher than the trade surplus and placed downward pressure on the Chinese currency.
Capital outflows have accelerated again in the fall. (IIF)
But rather than embracing this opportunity to let the currency slide and create an advantage for exporters, China sold off $1 trillion of its foreign currency reserves to keep the yuan relatively stable - and therefore give a fake impression of stability. So if anything, China has been manipulating the currency up, not down, for at least the last couple of years.
This type of manipulation continued after the U.S. elections, as Treasury bonds were sold en masse. Prices fell, and yields rose in a highly correlated fashion with the rise of the dollar against the yuan.
Maybe the Chinese want to wait and see what Trump proposes before letting the currency loose completely. Or would they like to show their power, to tell the president-elect they can move Treasury markets at a whim?
"Don't look for China to 'dump' Treasury bonds. That is a widely mistaken notion. The dollar is the only currency big enough to hold Chinese reserves," said Christopher Whalen, head of research at the Kroll Bond Rating Agency in New York.
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