Why a stronger yuan, not tariffs, may be Trump’s best hope to shrink US trade deficit
- Neal Kimberley says the dollar’s strength has widened the trade deficit by making US exports more expensive and goods it imports cheaper, defeating a purpose of Trump’s tariffs
US President Donald Trump may be a self-proclaimed “Tariff Man” but there’s no evidence from trade data that US levies on imports from China are eating into the size of America’s trade deficit. In fact, that deficit has soared again. A cheaper US dollar would probably help the situation but, for that to occur, it might need yuan strength to lead the way.
In spite of, or perhaps influenced by, US tariffs on imports from China, the US trade deficit hit a 10-year high in October. The median forecast of economists polled by Bloomberg had been for a figure of US$55 billion but the data released on December 6 showed the actual number was US$55.5 billion.
That US$55.5 billion figure represented a rise of 1.7 per cent from September’s US$54.6 billion, a figure which itself had been revised up from the original US$54 billion. The keynote US goods trade deficit with China jumped to a record US$43.1 billion in October, up 7.1 per cent from September’s US$40.2 billion.
The deterioration in China-US trade relations, and particularly Washington’s resort to tariffs, must surely explain at least part of the increase, with Chinese exporters front-loading shipments to avoid such imposts. In mid-September, the Trump administration not only announced a new 10 per cent tariff on US$200 billion of Chinese goods but also that it would rise to 25 per cent on January 1.
The fact that the tariff escalation has now been put on hold to allow for 90 days of China-US trade negotiations doesn’t mean it has been taken off the table. China’s exporters might rationally choose to use that 90-day window to keep front-loading cargo shipments into the United States.
Of course, there would be no point in Chinese exporters acting in such a way if there were no real expectation of selling those goods in the US market. It might not go down well in the White House but it may be that US demand for Chinese goods is relatively inelastic and that, regardless of tariffs, US demand for Chinese goods remains solid.
At the same time, retaliatory Chinese tariffs on goods such as US soybeans are biting. As regards US exports, US bank Wells Fargo noted that last week’s data showed a fifth monthly decline in US exports of food, feeds and beverages. “Weakness here continues to be led by declines in soybean exports due to the distorting effects of tariffs imposed earlier this year,” the firm wrote.
And US dollar strength in 2018 has worked against the erosion of the US trade deficit.
“The trade-weighted value of the US dollar against other major currencies has risen about 5 per cent since the beginning of the year,” Wells Fargo wrote. That currency effect has made foreign-currency-denominated imports into the US cheaper in US dollar terms and US exports more expensive in local currency terms for overseas buyers.
Part of that US dollar appreciation is accounted for by the rise in the value of the currency versus the yuan, and part of that weakness in China’s currency lies in the notion that the imposition of US trade tariffs on Chinese exports should lend itself to some degree of yuan softness.
To the extent that Chinese exports to the US have thus far not been adversely affected by tariffs, such a rationale might need to be revisited, perhaps implying room for yuan strength and some broader US dollar weakness.
US firm Morgan Stanley, on December 6, characterised the yuan as “anti-dollar”, arguing that “a weaker [yuan] leads to broad [US dollar] strength and vice versa”. It expected a “stronger [yuan] post G20”. As their analysis also shows an inverted correlation between the euro/US dollar and the US dollar/yuan exchange rates, yuan appreciation may also see the US dollar fall against the euro.
Such dollar weakness might eat into the size of the US trade deficit, enhancing US exporter competitiveness by making exports cheaper in local currency terms for overseas buyers. Where US demand for imports from abroad is more elastic, dollar weakness might make such imported goods less attractive to American consumers.
But for such a scenario to unfold, it might require the market to re-evaluate its view on the consequences of US tariffs on China’s economic prospects.
It’s ironic, but for the market to deliver a weaker US dollar that might actually erode the US trade deficit, the market may have to conclude that the Trump tariffs, the central plank of the US strategy to shrink the trade deficit, aren’t working.
Neal Kimberley is a commentator on macroeconomics and financial markets