Trade conflict risks igniting currency war

China’s currency fell to an 11-year low against the US dollar, prompting US authorities to brand the country a currency manipulator.

"Every now and then, August belies its reputation as a sleepy month," saysLarry Elliott in The Guardian. Last week, China's currency (the yuan, or renminbi) fell to an 11-year low against the US dollar, tumbling through the level of seven-to-the-dollar, previously regarded as a "line in the sand". That prompted US authorities to brand the country a "currency manipulator" for the first time since 1994.

There is now talk of a "currency war", says Jill Treanor on BBC News whereby nations competitively devalue their currencies to boost exports. There are signs that this game of "beggar-thy-neighbour" has already begun. Last week brought interest-rate cuts from central banks in New Zealand, Thailand and India (see opposite). Cuts tend to weaken currencies because they prompt investors to look elsewhere for a better return.

Currency contagion and the 1930s

It's certainly another headache for investors, says Mark Atherton inThe Times. Renminbi weakness carries the risk of a "deflationary shock being sent around the world as markets are flooded with cheap Chinese goods". The worsening trade dispute is also likely to spell trouble for big US brands such as Apple and Walmart. "China's billion-strong army of consumers can make or break any foreign brand selling in their country."

The yuan's fall has "revived memories" of August 2015, when a surprise mini-devaluation panicked markets, saysSteven Russolillo in The Wall Street Journal. "Hundreds of billions of dollars" left China in the aftermath as citizens and companies moved funds offshore.

The trade war is getting uglier

That said, fear of renewed capital flight is likely to prevent China from pursuing a bigger fall in the yuan, notes Russolillo. "Any further sell off could also create problems for Chinese property developers" and conglomerates, which have loaded up on overseas debt, but must pay it back with yuan-based earnings.

A disorderly rout is unlikely, agrees Arthur Kroeber of Gavekal Research. "At the risk of splitting hairs," recent weakness should be seen as a depreciation rather than a devaluation, driven by genuine market forces rather than official fiat. Nevertheless, the risk is that, despite this week's tariff reprieve, "the US and China are close to throwing in the towel on a trade deal".

Recommended

Sterling accelerates its recovery after chancellor’s U-turn on taxes
Currencies

Sterling accelerates its recovery after chancellor’s U-turn on taxes

The pound has recovered after Kwasi Kwarteng U-turned on abolishing the top rate of income tax. Saloni Sardana explains what's going on..
4 Oct 2022
The MoneyWeek Podcast with John Mills: why a weak pound is good for the UK
UK Economy

The MoneyWeek Podcast with John Mills: why a weak pound is good for the UK

In a special bonus mini-podcast, Merryn talks to John Mills, founder of consumer goods distributor JML, chair of Vote Leave and one of the Labour Part…
3 Oct 2022
Bank of England spends £65bn to “restore orderly market conditions”
Budget

Bank of England spends £65bn to “restore orderly market conditions”

The Bank of England has said it will spend £65bn buying bonds to stabilise the financial markets after the government’s mini-Budget. Saloni Sardana ex…
29 Sep 2022
Could gold be the basis for a new global currency?
Gold

Could gold be the basis for a new global currency?

Gold has always been the most reliable form of money. Now collaboration between China and Russia could lead to a new gold-backed means of exchange – g…
22 Sep 2022

Most Popular

Should you take a 25% tax-free pension lump sum in instalments?
Pensions

Should you take a 25% tax-free pension lump sum in instalments?

Taking out a 25% tax-free lump sum sounds appealing but it might not be the best way to manage your pension
30 Sep 2022
October’s Premium Bonds: how to check if you are a winner
Savings

October’s Premium Bonds: how to check if you are a winner

NS&I has added almost 110,000 more prizes to October’s Premium Bond draw – are you a winner?
4 Oct 2022
Section 75 refunds: protection for your credit card purchases
Credit cards

Section 75 refunds: protection for your credit card purchases

Under Section 75 of the Consumer Credit Act 1974, your credit card can give you extra protection when the goods or services you buy fall short of your…
23 Sep 2022