The US-China currency wars are in an unstable lull

So where did the currency wars go? The renminbi and yen are at their weakest against the dollar since 2008 and 1990, respectively. The Chinese current account surplus, properly measured, is probably at or approaching a record high. The White House is obsessed with boosting US manufacturing and what it regards as unfair competition from China. Yet Joe Biden and Xi Jinping met on Wednesday and exchange rates were barely, if at all, on the agenda. 

While this is a lull, it is highly unlikely to be a permanent peace. The factors that created battles over currency misalignments have not gone away. China in particular is threatening to return to the sort of mercantilist behaviour that started protracted tensions 20 years ago.

The US, despite strong objections to China’s trade-distorting protectionism and domestic subsidies, hasn’t fussed much over the renminbi’s value or China’s trade position. Last week, the US Treasury’s twice-yearly currency report, which in the past has formally labelled China a manipulator, was released with barely a ripple of discussion.

There are several reasons for this. With the US economy recovering remarkably well from the pandemic, a stronger dollar helps keep down inflation, which seems to be a higher priority for voters than growth and jobs, and makes it easier for the Federal Reserve to cut rates.

Biden’s own interventionist industrial policy is focused on products like electric vehicles for the American market rather than exports. And the tariffs against imports from China his administration has largely retained from the Trump presidency protect US companies against an undervalued renminbi.

It’s remarkable how little has changed with the dollar in the past few years, both cyclically and structurally. The US currency’s trade-weighted rise of about 10 per cent over the past two years has essentially reflected traditional factors of better growth prospects and higher interest rates. It weakened around this time last year and again somewhat over the past month as yield differentials narrowed. 

There are also few signs the dollar’s international role is seriously being eroded. True, the People’s Bank of China has started lending in renminbi to more countries using swap lines — including Argentina, a country with well over a century’s experience in finding new creditors to soak for cash. There is also some limited trade denominated in local currencies to avoid Ukraine-related US trade and financial sanctions. But China itself, despite some suggestions to the contrary, has kept its own reserves in dollars, and the US currency remains overwhelmingly dominant in global payments systems. 

There is no real sense of a global crisis from exchange rates that would cause the US authorities to act. Yes, a strong dollar hurts lower-income countries in general, and some lower-income African and Asian nations with dollar-denominated sovereign debt loads are in trouble. But bigger emerging markets such as Brazil and India have largely shifted into borrowing in local currencies.

Nor is there evidence that currencies are currently being systematically manipulated to gain a competitive advantage. Over the past few months the PBoC seems to have acted to stabilise the renminbi rather than depreciate it, and tighter monetary policy in Japan suggests the Japanese authorities are not targeting a weaker yen.

The crunch might come if the US economy does slow and, perhaps under a Trump presidency, the tap on its large domestic green subsidy programme is turned off. Weaker domestic demand means the US will need to look more to exports to keep the recovery in American manufacturing going.

If Beijing has similar aspirations, there will be a direct clash. Economic growth in China has disappointed this year. The government’s desperation to keep its economy growing may lead it to return wholeheartedly to the export-promoting model that characterised China’s charge to middle-income status after 1990.

As Brad Setser of the Council on Foreign Relations points out, China has a choice between returning its economy to full employment via fiscal stimulus, which boosts domestic consumption, or via monetary stimulus, which will weaken the exchange rate and offset internal weakness with a rising trade surplus.

Moreover, China’s massive investments in production, notably in EVs and semiconductors, are producing gluts that have to be offloaded abroad. The EU is already bracing itself for a surge of EV imports from China and contemplating antisubsidy duties to slow it.

A mercantilist battle for export markets make renewed currency wars much more likely. And there are no established policy protocols to bring peace, despite years of wrangling in the 2000s and 2010s over correcting misalignments and current account imbalances.

Global imbalances reflect domestic misalignments. China’s growth troubles can easily spill over into the tradable sectors of economies elsewhere. A slowing of growth, a widening of deficits and surpluses and the currency wars could easily start up again.

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