US economy

China’s discreet option on trade


US president Donald Trump has deepened the trade dispute with China by singling out microeconomic players such as telecoms equipment maker Huawei. Speculation has mounted that China might retaliate at the macroeconomic level by pushing its currency lower to make its exports cheaper, or by liquidating its hoard of US Treasury bonds to hurt the US economy.

Both fears are unrealistic. It is more likely that China will gradually reallocate its holdings from US sovereign bonds to those of other countries to support the renminbi. This would allow it to quietly give Mr Trump what he wants — a reduction of the US trade deficit with its biggest trading partners.

The renminbi has fallen sharply against the dollar since the trade negotiations between the US and China fell apart. At the time of writing, one dollar buys Rmb6.9, very close to the Rmb7 mark that most analysts believe to be a critical downward threshold.

Some analysts believe that China is “weaponising” its currency, allowing it to fall so that the additional tariffs US consumers pay on some Chinese goods are offset by lower US dollar prices resulting from a weaker renminbi.

This line of thinking is compelling: China has manipulated its currency to artificially low, export-invigorating levels in the past. But it seems unlikely that the renminbi’s current fall is the work of Beijing.

Firstly, every time the trade conflict has escalated, the renminbi has suffered. Secondly, Beijing has already been gradually reducing its holdings of US Treasuries, a sign that it wants to support, not weaken its currency. Thirdly, current market volatility makes it dangerous to play with depreciation: it could cause a mass sell-off and capital flight. Finally, devaluing the renminbi would further inflame Mr Trump.

Analysts have also been speculating about the use by the People’s Bank of China (PBoC) of its “nuclear option” of selling its enormous trove of US Treasury bonds, amassed as a consequence of years of manufacturing-driven trade surpluses. The US Treasury reckons that China holds more than $1tn of its bonds. Selling them could cause their prices to tank and their yields to soar, triggering a US stock market sell-off as money flowed into bonds.

This nuclear option would be very destabilising for the US — but, crucially, also costly for the world economy, China included. If China dumped its Treasuries, the value of its portfolio would plummet as it was forced to accept lower and lower prices to find buyers.

Destabilising the US would also be doubly costly. The Chinese economy still depends to a large degree on Americans buying its goods; a destabilised US economy would hurt Chinese industry considerably. Liquidating US Treasuries is a double-edged sword that any sensible Chinese leader would consider drawing only as a last resort.

Speculation about the nuclear option was fuelled by the PBoC selling $20bn of Treasuries in March, its biggest monthly sale for two and a half years.

But such fears ignored the fact that the bank has been gradually selling US Treasuries since September, mainly to keep the renminbi inside the line of 7 to the dollar as the trade dispute led investors to move funds elsewhere. Continuing on this least spectacular of paths may be the most attractive option for Beijing.

If the PBoC continued its gradual sale of Treasuries, the US Federal Reserve could print money with which to buy them, keeping markets steady.

The dollar would come under pressure as China exchanged its holding for the bonds of other countries. As a result, China would reduce its reliance on US financial markets, weaken the dollar, and weaken American purchasing power.

Most likely, China would shift to euro-denominated sovereign bonds, the eurozone being the only economy comparable in size to the US. With some $27tn in debt securities outstanding, the eurozone bond market is almost as big as that of the US, at $40tn.

European bond yields, already low, would be pushed down even further by the added liquidity, meaning China would earn even less interest than on its US Treasury holdings. But the euro would be likely to rise against both the US dollar and the renminbi, which would cause Europeans to buy more goods from the US and China.

The interconnected global economy means that even China’s least spectacular option would have far-reaching effects. A continuation of US Treasury sales would weaken the dollar against the renminbi and the euro; European and Chinese consumers would find that US goods become cheaper and more alluring, while Americans would find Chinese and European goods more expensive and not buy so many.

China could, then, quietly reduce the US trade imbalances with China and Europe. Mr Trump might hail the lower US trade deficit. But export-dependent European businesses would be more critical and perhaps demand EU politicians “take control” of international trade by, for instance, imposing tariffs, much as Mr Trump likes to do.

Maximilian Kärnfelt is an analyst at the Mercator Institute for China Studies, Berlin



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