A closer look at the currency war with China

Heated exchanges between world powers are leading to higher tariffs.

By SHLOMO MAOZ
August 4, 2018 05:36
A closer look at the currency war with China

Chinese President Xi Jinping speaks to representatives of Arab League member states at a China Arab forum at the Great Hall of the People in Beijing, China, July 10, 2018. . (photo credit: THOMAS PETER/REUTERS)

 
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On March 22 of this year, US President Donald Trump launched a trade war with China. The reasoning behind this decision was the claim that China is exporting goods to the US based on know-how belonging to American companies, and as a result was stealing intellectual property.

Trump’s declaration was based on an investigation carried out by the US Department of Commerce, which had recommended imposing $30 billion in new duties on goods that are imported to the US from China every year. Trump doubled the amount, threatening to increase tariffs on imports to $60b.

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Since then, a currency war has been escalating. Last week, following some heated exchanges between the two world powers, Trump declared that if needed, he would be willing to slap tariffs on all $505b. worth of goods imported from China. Beijing was left powerless. The only way it could retaliate was by imposing its own tariffs on goods it imported from the US, which amounts to only $130b. a year. (It must be noted that to date, each country has imposed tariffs on goods worth $34b. a year. The remaining tariffs are being examined and have not yet been enforced.)

The Chinese were shocked. They couldn’t believe what was happening to them. Maybe this was all just talk? Maybe Trump would change his mind? What would the nations of the world have to say about the US, the champion of globalization? However, as the days passed, Chinese President Xi Jinping realized that Trump was about to destroy the tower of cards China had built, which had by now turned into a steel tower.

Construction of the new China began in 1978, when then leader Deng Xiaoping vigorously jump-started the Chinese economy and steered it toward a free market economy, thereby burying the Mao era. The result was that in 2014, China’s GDP rose 48% above what it had been before reforms had been carried out. Private businesses now made up 70% of the market. China was galloping forward, leaving the rest of the world to watch them in shock.

China surpassed Japan as the world’s second largest economy. China manufactures almost every item you can think of cheaply, and with increasingly high quality. It exports to countries all over the globe, all day and night, by sea, air and ground, without ever stopping or resting. China stunned the world with its staggeringly fast growth and steady increase in quality and quantities that were unprecedented, except perhaps in comparison with the Industrial Revolution of the second half of the 19th century.

China was a marvel that no one had predicted, a leader of the global economy. Almost overnight, hundreds of cities were constructed in China, where neglected villages had previously stood. China constructed 240 international airports and established a large number of diverse industries. And now the Chinese are thinking to themselves: Does Trump intend to destroy all of this?



The question at hand now is: What will China do with all this industrial power? What will happen to all the goods they’re producing? After all, there’s not enough buying power in the world to purchase all these items if the US turns its back on China. The Germans are in saving mode – their Gross National Savings is currently at 28% and is expected to increase over the next few years. Germany’s current account surplus of 8.2% is unparalleled.

WHAT ABOUT Germany’s neighbors? Maybe the Catholic French, who love going on vacation and whose savings rate of less than 22% and current account deficit of -1.5%, would want to increase their trade deficit with China? Forget it. Maybe the UK, which is floundering and cannot decide whether to swallow or vomit Brexit? Absolutely out of the question. Maybe Eastern European countries that are barely able to keep themselves afloat will begin purchasing more Chinese products? Unlikely.
What about the Japanese, China’s neighbor to the east? With its savings rate of 28.3%, which is meant to provide for the country’s aging population, might Japan become a destination for Chinese goods? Keep dreaming. Japan doesn’t have any physical space for more Chinese products, it’s so small and crowded. Not to mention the historical hostility between the two countries, especially since the Second World War.

We won’t tire you out by discussing the dismal state Russia and the former Soviet republics are in. And clearly India is not an option, or Latin America, which is practically bankrupt. The bitter reality that China is now facing is that other than the US, it has no other country to sell to. Therefore, the US has the power to compel China to do whatever it wants. For three weeks, China has been in a state of shock, unsure how to proceed. Finally, it realized that it must become more competitive under Trump’s new tariff regime, and feeling under duress, it launched a currency war against the United States.

In the ancient world, there were currency wars. Countries would simply reduce the amount of gold in their coins, thereby reducing their value. The modern term, currency war, was coined by then-Brazilian finance minister Guido Mantega in September 2010, at the height of the global economic crisis. At the time, most of the countries were already members of the World Trade Organization, and therefore didn’t dare to make it difficult to import products to their countries or to impose non-tariff restrictions. However, in their distress, each country searched for a way to remain competitive and ensure exporting unemployment to other countries. The easiest way to accomplish this is by devaluing a currency so that other countries’ products will be more costly. As
a result, exports will grow due to lower labor costs and yield in terms of foreign currency.

Following the outbreak of the currency war, Israel’s central bank, for example, intervened directly in foreign currency trading, began supervising foreign currency transactions and instigated extensive monetary easing – i.e., printing more money. The US printed $3.3 trillion, which caused the value of the dollar to depreciate and made American-made products more competitive. The US rejected claims that its actions had been intended to devalue the dollar and thereby increase the US economy’s competitiveness.

The European Central Bank, which at first was afraid to follow in the Americans’ footsteps, took years to pluck up the courage to print more money (which has now reached 2 trillion euro). Such a crude intervention had never been made ever before. People around the world trembled as they waited to see if the printing of cash would bring about global inflation as it had just before World War II, when the Weimar Republic fell. What saved the world and prevented global inflation was China’s flooding the world with cheap products in increasingly large quantities, at the same time that the Americans courageously began its currency printing adventure.

On April 19, the local currency was worth 6.28 yuan to the dollar. But not anymore. The Chinese, who control the exchange rate, began devaluing the yuan on a daily basis in order to gain a relative advantage against the US and the rest of the world. By mid-June, Beijing was still hesitant, and began claiming that they were up against a currency war. But in actuality, the Chinese carefully devalued their currency to 6.4 yuan per dollar. Later on, they began aggressively pushing the yuan into a nosedive towards 6.8 yuan to the dollar, a decrease of nearly 8%.

In this fashion, China wants to restore its economy’s competitiveness that was lost with the imposition of American tariffs, which made the products they’re exporting to the US market more expensive. This will also help China gain a relative advantage over other countries around the world. South Korea, China’s rival, has devalued its currency, the won, more than 5% since June 6. It is not interested in having China strengthen at South Korea’s expense. At the same time, Taiwan devalued its dollar by 3%, Australia devalued its dollar by 3.8% and New Zealand by 2.8%. For the time being, it’s apparent that a low-intensity currency war is ensuing.

Trump warned China back in February of 2017 that it better stop manipulating its exchange rate in order to gain a relative advantage vis-a-vis the US. But now, following Trump’s latest move, it’s opted for an outright currency war, albeit not an officially declared one.

According to the US Trade Act of 2015, the US can declare that a country is manipulating trade if three conditions are met: The manipulating country must have a significant trade surplus with the rest of the world; it must have a significant trade surplus with the US; and it must be continuously intervening in its foreign-exchange market in an effort to push its currency in a certain direction. All of these conditions have been fulfilled in the current situation. China may find itself not just in trouble with Trump, but also with the US Congress and the American legal system.

LAST WEEK, Trump announced that he’s had enough with seeing the dollar strengthen with respect to other currencies around the world and that as a result, he foresees that the Fed (the US Federal Reserve) will not raise interest rates as planned. By saying this, Trump was in essence informing Fed chief Jerome Powell that the US should also join the currency war, although he too has refrained from stating so outright.

In the meantime, Trump is not launching an offensive against Japan, which is busy printing money and turning into an exporter of capital in the world with which it is purchasing bonds around the world (mainly in the US). This is causing the yen to weaken against the dollar. Japan is considered an American ally. Since the US dropped atomic bombs on Hiroshima and Nagasaki, Japan has been very careful not to make trouble for the Americans.

These bombings brought an end to World War II, which broke out mainly due to the severe worldwide economic depression, which began in the US and then spread to rest of the world. This led to a sharp rise in unemployment and to the decision to devalue currencies – in effect, carry out a currency war – and every country began exporting unemployment. In the end, no single country ended up having an advantage over another since they were all busy devaluing their currencies and imposing trade restrictions. The result was global unrest among workers and the unemployed, as well as hyperinflation in Germany, which led to the terrible war and the Holocaust.

Israel, because of its economic strength, is not really involved in this trade war. It’s true that the Bank of Israel is purchasing foreign currency in order to prevent excessive appreciation, but this step is being taken to prevent widespread unemployment. After all, the shekel has strengthened and appreciated against the effective exchange rate at a strong real interest rate of 8.2%, with an emphasis on the word “real.” One thing that we can learn from our tiny country is that it’s possible to succeed, even without engaging in a brutal trade war.

Translated by Hannah Hochner. 

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