Investors Fear China Might ‘Weaponize Its Currency” in the Trade War

Investors Fear China Might ‘Weaponize Its Currency” in the Trade War

  • Posted by: Peter Pang
  • Category: Foreign Direct Investments, Outbound Foreign Investments
US-China Trade War

The US Council on Foreign Relations lists the US-China trade war as the most significant world event of 2018 – and it seems more than plausible that this event will retain its title in 2019. The frightening aspect of this scenario is the fact that neither side has exhausted its arsenal of weapons that could be used should either side elect to escalate the conflict. One of the weapons at China’s disposal is the value of its currency.


The US Complaints That Ignited the Trade War

report issued by the Office of the US Trade Representative on March 22, 2018 summarized the rationale for the trade war by asserting the following complaints:

  • The US-China trade deficit is too high and growing rapidly.
  • China’s technology transfer regime is unfair to US investors due to forced technology transfers.
  • US firms are unfairly disadvantaged in licensing and other technology-related negotiations with Chinese parties.
  • The Chinese government unfairly facilitates the acquisition of US companies that possess technology regarded as important by the government.
  • China is engaging in state-sponsored cybertheft of US intellectual property.

China has denied some of these allegations (the allegations of state-sponsored cybertheft, for example), and has defended others by, for example, characterizing “forced” technology transfers as simple negotiated outcomes.


US Tariffs and Chinese Counter-Tariffs

The tit-for-tat tariff war between the US and China is volatile, and it is changing so quickly that each day’s headlines bring new developments. At the time of this writing, the US has imposed tariffs on more than $360 billion of Chinese products, while China has imposed tariffs on more than $110 billion of US products.

The latest round of US tariffs targeted a wide variety of Chinese products with a 15 percent duty, to which China retaliated with its own tariffs ranging from 5 percent to 25 percent on various US imports. Both economies are feeling negative effects, and experts fear that further escalation could significantly dampen economic growth in both countries and perhaps even push the US into a recession during an election year.


The Devaluation of the Yuan and Its Potential Consequences

China’s currency is one of dozens of currencies around the world that are ‘pegged’ to the US dollar. China’s central bank establishes the exchange rate for the yuan against the dollar every morning, and it allows the yuan to fluctuate by up to two percent against the dollar throughout the trading day. The central bank, as well as commercial banks, is empowered to buy or sell currency to stabilize the value of the yuan.

So far in 2019, the value of the Chinese yuan to the US dollar has drifted from a high of 6.69 to a low of 7.17, with a decisive downward trend since early May. At least one of the reasons that China has allowed the value of the yuan to fall is obvious: It makes Chinese products cheaper for US consumers, who pay in dollars, thereby helping to offset the increase in the retail price of Chinese goods caused by the imposition of tariffs.


US Vulnerability

The disadvantage that a significant fall in the value of the yuan poses to the US interests are almost as obvious:

  • It makes US products more expensive in China, rendering them less competitive (thereby tending to aggravate the trade deficit).
  • It makes the stock market nervous. In early August, the Dow lost 767 points, its worst day of 2019, immediately after China allowed the yuan to slide below the symbolic barrier of 7 yuan to the dollar for the first time in 11 years. The sell-off spread to world markets as well.
  • It signals a significant escalation in the trade war, as well as the possible opening up of a new front – currency warfare – that many stateside experts are convinced the United States would lose.


US Designates China a ‘Currency Manipulator’

Shortly after China allowed the yuan to slide below 7 to the dollar, the Trump administration labeled China a ‘currency manipulator’ for the first time since 1994. Strictly speaking, this designation doesn’t necessarily mean a whole lot. After designating a country as a currency manipulator, the Treasury Department is required to demand negotiations and it may impose sanctions such as exclusion from government procurement contracts.

Mainland China is not the only jurisdiction to ever receive this designation – the US has named Taiwan and South Korea as currency manipulators in years past. The Trump administration has pledged to work with the IMF on this matter, and it is pressuring the US Federal Reserve to respond. Trump, however, lacks the direct authority to compel the Federal Reserve to respond.


China’s “Nuclear Option”: Selling Off US Treasury Bonds

China is the United States’ largest creditor, on the strength of the $1.1 trillion in US treasury bonds that it holds, and a massive sell-off of these bonds could trigger a level of economic disruption that we have not seen so far. Although, strictly speaking, this would not constitute currency manipulation, its indirect effects would almost certainly impact the value of the yuan.

A massive sale of US treasury bonds could backfire on China in several ways, one of which would be the value of the yuan. Although this would certainly threaten the US economy, if China begins selling massive quantities of US bonds, the value of its remaining bonds would plummet, making it more difficult for it to maintain the resources necessary to defend the value of the yuan.

Even if China does “weaponize” its currency, it would be aiming for a controlled fall in its value to a stable floor. Anything further than that could trigger massive capital flight from the country, which could potentially inflict serious damage to the Chinese economy.

It is unclear when or how the escalatory cycle will end or what the ultimate effect on the two economies will be. Some observers are convinced that China’s strategy is to “wait out” Trump in the hopes that he loses his re-election bid in 2020. Ultimately, however, no one is really sure how things will play out.


IPO PANG XINGPU, with headquarters in Shanghai China, we have been helping clients from all over the world with their legal matters since 1992. We are a group of dedicated attorneys and professionals with expertise and experience in a variety of legal disciplines.  Clients come to us “When Being Right Matters ®”.

Author: Peter Pang
Peter C. Pang* is Chairman and Managing Partner of IPO PANG XINGPU LAW FIRM., His expertise includes corporate law and formation, franchising – inbound and outbound, mergers and acquisitions, real estate acquisitions, private placement, technology transfer, joint venture formation and business alliances, and trade secrets and intellectual property protection. Mr. Pang’s over 35 years of law practice in the People’s Republic of China and the United States places him amongst a handful of US-China lawyers with Asian International Expertise and in-depth appreciation for both the Western and Asian cultural and business differences and sensitivities. Mr. Pang is an attorney who “not only knows, but knows how” to close a deal, litigate vigorously and represent clients zealously. We don’t sell time, we sell solutions ™.

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