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COMMENTARY: Trump's Trade War Spirals Further Out of Control

Mark Melnicoe 2019-08-10 20:05 PM

The tit-for-tat between the United States and China this week reveals all you need to know about the trade war. Thanks to President Trump’s continuing miscalculations, it’s mushrooming further out of control and barreling toward a point of no return.

Events unfolded swiftly on Monday when China’s central bank let the nation’s currency, the yuan, fall to beyond 7 to the U.S. dollar. It marked the yuan’s lowest point in 11 years, and stock markets around the globe immediately swooned. Wall Street fell about 3 percent.

Before the day was out, President Trump had taken the rare step of designating Beijing a foreign currency manipulator – the first time the U.S. has made such an official accusation against any country since the early 1990s.

That prompted the People’s Bank of China to call Trump’s move an act of “protectionism” that “seriously violates international rules and cannot be justified by the U.S. Department of the Treasury’s own standards for applying the label.”

As has usually been the case throughout the trade war, China was right and Trump was wrong. Economists agreed that the yuan’s fall was a normal, mild reaction to trade tensions that were ratcheting up with Trump’s sudden announcement that he would put 10 percent tariffs on another $300 billion of Chinese imports effective September 1.

The PBoC had said for months that it was willing to let the yuan, also known as the renminbi, fall below the symbolic 7-to-the-dollar level if external pressures (such as tariffs) dictated it. And that’s exactly what happened. Why is Team Trump surprised?

And while the devaluation was mild, it’s true that Beijing likely was sending a signal that it had more weapons to play in the broadening economic war. It’s hard to fathom how else Trump thought the Chinese leadership would react when he announced the tariffs – a move that went against an agreement he made with Chinese President Xi Jinping and announced publicly at a meeting in Japan June 29.

If anything, Trump was years late in making the declaration. China has actually been propping up the yuan since 2015, and it has fallen against the dollar less than most foreign currencies.

Beijing took steps to stabilize the yuan the rest of this week, but it’s also hinting at further devaluations.

In any case, the U.S. Treasury’s manipulation charge was both spurious and meaningless. Spurious because it accuses China of keeping its currency lower when in fact it’s been doing the opposite for years. Meaningless because there’s little the U.S. can do about it.

In truth, Beijing can only go so far in letting the yuan fall before inflicting damage on itself. While the devaluation makes the country’s exports more competitive, to help offset the tariffs, it also makes imported products more expensive. The authorities in Beijing also are concerned about capital flight, and the lower the yuan goes, the greater the desire for China’s wealthy class to get their currency out of China into something safer.

The Tariff Way a Dead End

Treasury's action "is more symbolic than anything at this point and aimed at Trump's hard-core political base that he will need to shore up now that the economy is broadly decelerating in part due to the trade conflict," Joe Brusuelas, chief economist at RSM, told Politico.

Trump seems to think Xi will give in if he amps up the pressure enough when it’s obvious he won’t. China is digging in, and relations between the world’s two economic superpowers are seriously suffering.

The Communist Party’s People’s Daily and other state media have run a series of angry editorials denouncing Trump’s action on trade. The party knows how to use propaganda to shape public opinion, and it’s possible that Xi – a highly authoritarian figure who seeks to shut out foreign influence – will simply use the trade war to achieve some of his own xenophobic aims.

“The CCP has shown propaganda works, and the increasingly shrill anti-American invective since May will have a lasting effect on the US-China relationship,” the influential Sinocism newsletter said.

It went on to say that Xi “will be pleased with that change, as he likely believes Chinese have been too willing to admire America and sees an opportunity in the current trade war to reset views towards America.”

Goldman Sachs simply threw in the towel, telling clients in a note that “we no longer expect a trade deal before the 2020 election” – something that’s been increasingly obvious with developments since May, when once-promising trade talks broke up.

Already, China is breaking its vow to buy more American farm products, an agreement it renounced this week in addition to allowing the yuan’s decline. In return, Trump’s Commerce Department has put a freeze on any approvals for American companies to restart business with Chinese telecom giant Huawei, Bloomberg News reported Thursday.

The U.S. put Huawei on a blacklist, along with several other Chinese tech companies, as an offshoot of the trade war – ostensibly over national security concerns.

Economists are starting to voice worries about a trade and currency war that might echo the 1930s, when the Smoot-Hawley Tariff Act was blamed for prolonging the Great Depression.

While Trump’s complaints about several of China’s longstanding trade practices are legitimate (though accompanied by overblown rhetoric), virtually all economists agree that tariffs are the wrong way to approach a complex problem. So are Trump’s ever-shifting threats, policy reversals and insults. They are getting us nowhere, and the pain is about to get worse.