With the Chinese economy said to be slowing down, there have been concerns over whether Beijing will decide to use its most potent tool to flip the China-U.S. trade war in its favor — the yuan. Such a move would definitely unleash shockwaves in the international markets.
Devaluing the yuan to impact the US-China trade war
Import tariffs imposed by the U.S. have definitely dampened the spirits of Chinese exporters since the tariffs make their products more expensive in America. Not only does this erode their competitiveness, but it also squeezes margins. If Beijing does not do anything soon, manufacturers will move out of the country in droves in a bid to avoid paying the U.S. tariffs.
By devaluing the yuan, Beijing will be able to counter the effects of the import tariffs. For instance, if the Renminbi falls to 5.5 to the U.S. dollar from 6.5, Chinese manufacturers will be able to reduce dollar prices of their exports while keeping their earnings in yuan unaffected. This will essentially neutralize any tariffs imposed by the U.S.
“The devaluation could prompt an angry reaction from the U.S., which has consistently argued that the yuan is undervalued, damaging U.S. exports. It could also force other Asian countries to devalue, making exports to the U.S. cheaper and increasing Washington’s trade deficit further,” according to The Guardian.
Risks involved in depreciating the yuan
While devaluing the yuan seems like an excellent decision at first, a deeper study shows that it can actually backfire on the Chinese. “A sharp yuan depreciation would undermine Beijing’s deleveraging effort by driving capital flight and further tightening domestic financial conditions… It could also fuel inflation and dampen foreign investors’ growing interest in China’s domestic stock and bond markets,” Richard Turnill, Chief Investment Strategist at BlackRock in New York, said to Forbes.
A similar situation occurred in 2015 when Beijing intentionally devalued the Renminbi in a bid to help its factories. It triggered a chain reaction in the financial markets and assets started depreciating. Wealthy Chinese citizens began transferring money out of China fearing a domestic collapse.
In short, Beijing was left dumbfounded at the negative effects the devaluation caused. It had to shell out US$500 billion from its reserves to neutralize the situation. The Communist Party learned an important lesson from the incident — even if it wants to, Beijing cannot devalue the Renminbi in any significant way since it will bring disaster to the local economy itself.
Devaluing the yuan will also indicate to the world that China will play as dirty as it can in order to shift global trade in its favor. This will definitely hurt Beijing’s image among other countries. Fewer nations will trust China to trade fairly. And losing trust among the international community is not something Beijing can afford right now. Plus, it will give the U.S. all the moral right to place further sanctions against China, deepening the economic stagnation the Chinese economy is going through.
Such a move would also jeopardize China’s intention of making the yuan a major global reserve currency. After all, no one in their right mind will ever accept a manipulative currency as a reserve. Given the possibility of such negative consequences, it is very unlikely that Beijing will consider devaluing its currency.