U.S., China Trade Deal Leaves Currencies as Fighting Ground

(Bloomberg) -- The U.S. and China are edging closer to resolving differences on currencies that have bogged down economic talks for nearly two decades. The only question is how meaningful the deal will be.

With both nations inching towards a trade agreement that’s expected to include a provision for China to hold the yuan stable, U.S. President Donald Trump is shifting his gaze to the dollar’s strength.

During a largely unscripted two-hour speech on Saturday, he targeted Federal Reserve Chairman Jerome Powell as someone who “likes raising rates.” Even though his Treasury secretary sets currency policy, Trump pointed to Powell as a “gentleman that likes a very strong dollar.”

For China, a possible weaker dollar will lead to a stronger yuan, pressuring officials to halt its appreciation as the economy slows. That will risk triggering blunt criticism from Trump, who used his presidential election campaign to routinely accuse China of deliberately weakening its currency in order to boost exports.

"Trump wants the dollar to stay lower because of the impending election to counter the strengthening effects of his budget and Fed policy," said Douglas Paal, vice president for studies at the Carnegie Endowment for International Peace. "But if you were to ask him why, he might offer the excuse of China’s currency."

U.S., China Trade Deal Leaves Currencies as Fighting Ground

Keeping the yuan on a stable path won’t be easy given the slowing domestic economy and drawing on lessons from previous currency pacts such as the 1980s Plaza Accord, said Cliff Tan, MUFG Bank Ltd.’s East Asia head of global markets research.

"We still think a weaker economy and credit problems should mean a weaker yuan later in the year," Tan said.

The government in Beijing on Tuesday used its report to the annual National People’s Congress to lower its growth goal for the year to a target of 6 percent to 6.5 percent and pledged to keep the yuan basically stable at reasonable equilibrium levels, while also allowing greater flexibility.

That suits China’s own interests, given the risk of capital outflows and market instability that would be triggered by a currency slump. Yet it’s less clear how much sovereignty over the yuan China will want to cede in any trade agreement with the U.S.

China’s Reluctance

"It looks unrealistic to us that China would accept any explicit clause putting down ranges for the dollar-yuan rate or incorporating a vigorous monitoring process," Frances Cheung, head of Asia macro strategy at Westpac Banking Corp. wrote in a note Tuesday. "A rigid exchange-rate policy would have wide implications on China’s multi-year reform on the foreign-exchange system and the opening-up of the capital markets."

China’s yuan surged 2.5 percent against the dollar this year, making it the best performing currency in Asia, and has rallied to the highest level since July versus a basket of exchange rates. That’s a far cry from 2018, when the yuan tumbled more than 5 percent amid concerns over the trade war and monetary easing by the central bank.

A currency accord will likely require China to avoid devaluing to gain a competitive advantage, U.S. Trade Representative Robert Lighthizer said last week, though he also said that there isn’t yet a final agreement. That was a shift from Treasury Secretary Steven Mnuchin’s previous remarks that the U.S. and China had concluded “one of the strongest agreements ever on currency.”

Currency provisions have become an increasingly common feature of U.S. trade agreements in recent years. The Obama administration insisted on including a commitment to not engage in competitive devaluations in the Trans-Pacific Partnership it negotiates with Japan and 10 other economies. The Trump administration insisted on the inclusion of something similar in a renegotiated Nafta. 

But by and large the provisions have been seen as symbolic and toothless. The Trump administration has also proven reluctant to act on the president’s rhetoric before. During his 2016 campaign Trump promised to officially label China a currency manipulator and take tough action. Two years into his presidency, however, the U.S. Treasury has declined to follow through on that threat.

©2019 Bloomberg L.P.