The trade war escalates, and the fog of war descends

America brands China a currency manipulator, and global markets swoon

CARL VON CLAUSEWITZ, the Prussian military theorist, never wrote about currency wars. But some policymakers see them in his terms: as the continuation of trade politics by other means. That, at least, is how the Trump administration views China’s decision on August 5th to let its currency weaken past seven yuan to the dollar for the first time since 2008. Though arbitrary, that threshold has assumed huge symbolic importance among traders, economic officials and fund managers (see Buttonwood). They were left stunned.

America’s Treasury quickly branded China a “currency manipulator”, a charge it has not levelled against any country for 25 years. China, in the Americans’ view, was cheapening its currency to gain an unfair edge in retaliation for President Donald Trump’s surprise announcement four days earlier that he would impose new tariffs of 10% on roughly $300bn of Chinese goods.

This marked the end of investors’ hopes for a peaceful summer. At the end of July the Federal Reserve had cut interest rates to guard against a slowdown in America’s respectable growth rate, and trade tensions had “returned to a simmer”, as Jerome Powell, the Fed’s chair, noted with

satisfaction. But after the yuan’s move America’s stockmarket suffered its worst day this year. Emerging-market currencies, including the Brazilian real, Indian rupee and South African rand, fell. The price of Brent crude oil tumbled below $60 a barrel and safe havens, such as gold, rallied. The same search for safety pushed American ten-year government bond yields to 1.7%, as investors bet that the Fed would be forced to slash interest rates further to prevent a recession. The Reserve Bank of New Zealand cut its benchmark interest rate by twice as much as expected, citing “heightened uncertainty” and “historically low” global bond yields. The Australian dollar fell to its lowest level in a decade.

In matters of war and peace, countries must prepare for the worst. But precautions can look like provocations. In allowing the yuan to fall, China signalled it is prepared for a protracted trade war. It let the yuan weaken in response to the threat of tariffs much as a floating currency would. Otherwise it would have needed to defend an arbitrary line against the dollar every time America turned belligerent. Its move nonetheless makes further belligerence more probable. Mr Trump is now unlikely to change his mind about the new tariffs before they kick in on September 1st.

Both sides blame the other for starting the fight. China has raised tariffs only in response to America’s. But America sees its combative economic diplomacy as a belated response to decades of intellectualproperty theft and other misdeeds. Each side’s attempt to get even looks to the other like one-upmanship. China views a weaker yuan as a reasonable response to Mr Trump’s trade duties; Mr Trump, according to the Wall Street Journal, sees those tariffs as retaliation for China failing to commit to buy more American farm goods.

The irony is that Chinese purchases of American soyabeans and pork were already rising, and the government was offering buyers exemptions from some tariffs. But after Mr Trump’s new tariff threat it has reportedly told state-owned companies not to buy American farm goods after all. Thus Mr Trump’s tariffs may have caused the decision they were designed to punish.

Whatever the cause of the new levies, what might be their effect? Some of America’s existing tariffs (of 25% on roughly $250bn-worth of merchandise) had been imposed on Chinese goods that American importers can buy elsewhere. That minimised the harm to American buyers and maximised the harm to China’s exporters, which lost business to close rivals elsewhere. Indeed, according to Goldman Sachs, other Asian countries have filled around half of the gap created by the previous round of tariffs.

The next round of tariffs will hit goods for which China has fewer competitors. That should make it harder for American buyers to switch suppliers. Nonetheless the new tariffs’ direct impact could reduce China’s growth by at least 0.3 percentage points in 2020, according to UBS, to below 6% for the first time since 1990.