Forget yuan devaluation, what if Donald Trump weaponises the US dollar?
David Brown says China should take the high road and let the renminbi’s rate be determined by market forces even if the US president escalates a currency war
Savvy investors know full well that market plays are never safe one-way bets for too long. The US dollar has been king for most of 2018, having enjoyed its best run since 2015, but all good things generally come to an end.
Economic fundamentals have been kind to dollar bulls since early spring, but there is no guarantee of the rally’s life expectancy, especially if “crazy town” politics gain ground in Washington. Beijing had better be prepared to ride the coming storm as it might provide a valuable opportunity.
Currency plays are generally down to relative strength expectations about growth, interest rates and bond yields. The dollar has had a great run for its money as America’s economy has boomed, labour demand has surged, while the Federal Reserve has stuck to its guns on normalising interest rates.
This has won plaudits for the dollar especially as US interest rate and bond yield differentials have rallied in the currency’s favour. Trade war worries and unsettled emerging market conditions have also attracted considerable safe haven demand for the US dollar in recent months.
Most of the good news is already factored into the rally, but ugly politics could soon raise its head. US President Donald Trump’s recent troubles over White House leaks, the Russia collusion investigation, and books and newspaper articles disparaging his presidency are not helping market fears about the US administration lashing out with policies that could add to global instability over the future.
The big worry for currency markets is where Trump really stands on US dollar policy. Is he a strong dollar man or happier to play the weak currency card? So far the jury is out.
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Past US presidents have been renowned for their US dollar policy ploys. Ronald Reagan hailed the “superdollar”, Bill Clinton was a strong dollar advocate, while North American manufacturers reputedly browbeat George W. Bush into a weaker currency bias to boost export-led growth.
It is still unclear whether Trump is a true dollar friend or foe, but he dislikes “currency manipulators” and frets about Beijing playing the devaluation card. In Trump’s rule book, two can play at that game, especially given the surge in the dollar’s fortunes this year and its fallout on heartland support in the US farm and rust belts. A competitive currency counts in the US just as much as China.
Right now, Trump is threatening to step up his trade war with China, but the worry is that he will escalate pressure on Beijing with a currency war, too. With China threatening to retaliate with countermeasures, the markets are in a deep quandary. Clearly, equity markets are rattled, but could the instability start feeding into foreign exchange markets, adding another element of risk for investors?
Currency polls are in a dither, with forecasters looking at a wide spread of future exchange rate projections for the renminbi against the US dollar, ranging between 6.30 yuan at the lower end to 7.30 yuan at the top end in a year’s time, according to market surveys compiled by Reuters.
The 15 per cent variance underlines the market’s deep-rooted uncertainty about the future. The growing policy conflict between Washington and Beijing is clearly creating problems in an already troubled world, further undermining economic confidence and global growth prospects.
The US and China are both great nations but it is time for one side to stand tall and defuse the situation. This could be the golden moment for Beijing to present its better side to the world. It can either choose trade retaliation and currency devaluation as weapons of mass destruction or decide to step away from mutually assured damage.
If Beijing truly wants to internationalise the renminbi, it should go with the flow and let market forces prevail. Fighting a currency war with Washington is a zero-sum game and could set back the renminbi’s universal acceptance by years. Official currency tampering would be seen as a market anathema.
If Trump plays the cheap dollar card, markets could be looking at an opportunity for medium-term renminbi recovery. It could be early-2018 all over again with a return towards 6.30 yuan looking the more likely prospect ahead. Beijing should show its mettle through currency benign neglect and by setting a strong moral lead over the US.
David Brown is chief executive of New View Economics