The Chinese Yuan: Watching For A Currency Battle Too

Includes: CNY, CYB, FXCH
by: John M. Mason

The value of the Chinese renminbi has dropped significantly over the past two weeks as the tariff battle between the United States and China deepens.

Will the Chinese oversee a drop in the value of their currency in order to counter the actions of President Trump on tariffs. They have in the past.

Therefore, investors must also watch what is going on in the currency markets because governments can play many "cards" in the political battles that take place between nations.

Are the Chinese now playing with their currency as a part of the recent tensions over tariffs and trade issues?

Certainly, the recent drop in the value of the renminbi presents us with a scenario of the role the currency might play in current international discussions.

On April 12, 2019, it took only 6.6882 renminbi to purchase one US dollar.

On May 6, the price jumped to 6.7646. The reason for the increase was the note put out by US President Donald Trump setting out his “strong” position on the tariff talks taking place between the Chinese and the Americans.

The decline in the value of China’s currency accelerated. On Monday evening, May 13, the price increased further to 6.8783.

Monday, the People’s Bank of China, dropped the onshore rate’s trading band, and this was the third day it had done so.

Observers felt that this was a sign that the PBoC was not averse to further declines. Furthermore, this was the lowest level for the currency this year.

The arguments against such an interpretation is that this effort would be counter to the aim of the Chinese to develop a worldwide currency, one that was used everywhere and one that was held by other central banks, globally. This has been a long-term goal of the Chinese.

Still, the Chinese are not going to just “back off” from the tariff disagreements.

The Chinese government has used a weak currency in the past to boost trade.

And, right now, the PBoC does not look like it is going to avoid a further decline.

A key issue is how the US government will respond in the face of all that is going on.

Sam Goldfarb, in The Wall Street Journal, looks at this situation from another angle.

Mr. Goldfarb looks at the issue from the standpoint of all the risk-averse funds that have moved to the United States bond market seeking a safe haven. (I have recently written about this subject myself.)

In February 2019, according to the US Treasury Department, China held $1.13 trillion of US government debt, which was about 7 percent of all tradable debt.

And, although that is a much smaller share than what China held in earlier times, the size is still significant enough to disrupt the market if the Chinese decided they wanted to sell some of their Treasuries.

Mr. Goldfarb writes:

Some investors and analysts have warned that a significant decline in China’s currency could prompt China’s government to defend the value of the yuan by selling Treasurys and converting those dollars into yuan, putting upward pressure on Treasury yields.

China sold Treasurys in 2014 and 2015 and likely in 2018 to support the value of the yuan, said Brad Setser, an economist at the Council on Foreign Relations who studies the international flow of capital.

’I’d be surprised if there isn’t some intervention’ to support the yuan before it falls below recent points where Chinese officials have intervened in the past, he said, adding those levels would likely come before the yuan falls to 7 per U.S. dollar.

So we see how actions - or non-actions - in one part of the marketplace can impact other parts of the marketplace. And this is what investors have to judge.

Yes, one needs to be aware of what is going on relative to tariff talks, and one needs to be aware of what higher tariffs might do to world trade and economic growth, but an investor needs to also be cognizant of how governments can act in other ways.

The Chinese might really want to stand up to the Americans by not backing off of tariff increases, but they may also want to protect their economic growth by weakening their currency and keeping up their internal rate of economic growth.

On the other side of this, the Chinese still want their currency to be a major player in global affairs. This is why, as mentioned above, China sold Treasuries earlier in the decade to support the value of its currency. Seven yuan per US dollar seems to be an important floor.

The political uncertainty surrounding these decisions highlights the uncertainty that exists in the world today and results in flights of risk-averse monies to safe havens.

This is, of course, the subject that Mr. Goldfarb and I have been writing about in the articles cited above.

We just don’t know how far the battles will spill over and how the leaders of governments will play out their “zero sum” games. The Chinese believe that they can now go “head-to-head” with the Americans in situations like these.

This means it is an entirely different world than it was even just a few years ago. Investors, consequently, must take these facts into consideration.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.