Beijing has a powerful tool to respond to President-elect Donald Trump’s threatened new tariffs on Chinese goods: it could launch a currency war, a step that carries dire risks for both China and the United States — and certainly for the global economy. Depreciating the value of China’s currency, the yuan, against the dollar would be a tried and tested response to the new US administration’s tariffs. A cheaper renminbi would make Chinese exports less expensive for foreign importers, mitigating the damage to China’s competitiveness from Trump’s tariff war. It did so in 2018 and 2019 when the US president-elect imposed the tariffs during his first term. The cheaper renminbi could partially or fully offset the impact of the additional 10% tariff on Chinese goods that Trump announced on Monday, November 25, that he would impose on his first day in office. He also said he would impose 25% tariffs on goods from Canada and Mexico. A strategic devaluation of China’s currency, which is tightly controlled by the country’s central bank, could allow Beijing to rev up its powerful export engine.
- China’s total export volume to all destinations has already increased by almost 12% in the first nine months of this year compared to last year.
- China is poised to further expand its manufacturing capacity as its banks ramp up lending to build new factories.
- At the same time, the fall in China’s currency could put the country’s economy at risk.
- Faced with a weaker renminbi, Chinese companies and wealthy families may rush to move money out of the country rather than invest in the domestic economy.
- A weaker renminbi exchange rate against the dollar could also hurt Chinese public confidence in the domestic currency, reduce consumer spending and push down stock prices.
- It could also work against recent efforts by policymakers to support an economy battered by a housing market crash that has wiped out much of the savings of China’s middle class.
China’s central bank, the People’s Bank of China, came under heavy criticism when it suddenly devalued the renminbi in August 2015 and has been wary of allowing the domestic currency to fluctuate so sharply again. Liu Ye, the head of the international department, said at a press conference in November that the central bank would “maintain the basic stability of the renminbi exchange rate at a reasonable equilibrium level.” 
No one will win
But China is deeply hostile to any new tariffs. Responding to Trump’s threat, the Chinese embassy in Washington said: “China believes that China-US economic and trade cooperation is de facto mutually beneficial. No one will win a trade war.” Chinese companies have significantly increased their manufacturing capacity in other countries in recent years, building factories that assemble components from China into finished products for sale in the United States and elsewhere.
That has allowed some of them to bypass tariffs imposed by the United States during the first Trump administration. Many Chinese business owners have been moving money overseas in recent weeks to further bolster their operations there and ensure that China can maintain strong exports even if Trump imposes additional tariffs.
China’s exports to the United States have remained strong despite the tariffs in 2018 and 2019, as many Chinese companies ship in small quantities to avoid tariffs or customs scrutiny. China has also rapidly increased exports to Southeast Asia, such as Vietnam, and Mexico, where goods are assembled and packaged and shipped back to the United States with little or no tariffs.
In the days following Trump’s election victory in November, the renminbi fell about 2% against the dollar. It stabilized last week at 7.25 renminbi per dollar. Many other currencies have also weakened against the dollar.
Are the Chinese Selling Dollars? The Ideological Barrier and Xi’s Theory
The People’s Bank of China sets a daily exchange rate band, buying and selling currencies in conjunction with state-controlled banks to keep the renminbi within a narrow range. State-owned banks may sell dollars now and use the liquidity to buy renminbi to maintain the current exchange rate.
Trust Economics reports that the renminbi could fall another 9% or 10% if the United States immediately imposes tariffs on Chinese goods. That would mean it would take almost 8 renminbi to buy one dollar, an exchange rate level not seen since 2006.
China has for many years been willing to let the renminbi remain weak to fuel its exports. But the central bank has begun to face an unusual ideological obstacle to any sharp weakening of the currency.
At a rare gathering of Politburo members, ministers and provincial leaders in January, Xi Jinping, China’s top leader, gave a speech outlining his vision for “high-quality financial development.” Xi said maintaining a strong currency was essential for China to be an economic superpower, along with other essentials, such as a strong central bank and financial institutions.
What to do with the dollar – The new president’s dilemma
Donald Trump’s arguments against the excessive strength of the US dollar have some basis – but his position on how to deal with it remains unclear, and the only viable options available could upend broader US financial markets in the process.
Many of his economic ideas are expected to be put into effect after January 20 – including proposals for huge tariff hikes and sweeping tax cuts, challenging the independence of the Federal Reserve and cracking down on illegal immigration. But one argument remains steadfast and rooted in some economic logic: his insistence that the US dollar is overvalued.
The statement is not too controversial, given that the inflation-weighted dollar index has climbed 20-30% over the past 10 years. Even the International Monetary Fund’s analysis estimates that the dollar was about 5-10% overvalued last year, with the currency set to gain another 2-3% in 2024. Trump’s criticism is that the dollar’s excessive strength has eroded the competitiveness of U.S. exports, ballooned the trade deficit, and hurt U.S. manufacturing and jobs. And many agree with that assessment.
Why does excessive monetary privilege persist?
It is harder to prove that the dollar’s strength is due to the malign actions of foreign governments—even if there is broad agreement that U.S. trading partners will resist a weaker dollar at a time when the U.S. economy is already outperforming most of them.
Others argue that the causality surrounding the dollar’s strength works in reverse. U.S. economic outperformance—combined with the U.S.’s cutting-edge technology sector and the unrivaled liquidity and size of U.S. financial markets in general—has capped tens of trillions of dollars of private global investment in Wall Street securities over the past decade and inflated the dollar’s value in the currency mix.
If the US “monetary exceptionalism” is real, the argument goes, then a historically high dollar valuation simply reflects that. Any serious attempt to weaken the currency would risk upsetting the same global financial flows.
Trump advisers have been looking for ways to “devalue” the currency beyond the imposition of basic trade tariffs. It has never been clear what exactly that approach would entail, other than some kind of international pact to sell dollars on the open market.
However, this is unlikely, as few of the United States’ allies would likely participate in such a plan, as was the case during the currency interventions of the 1980s.
Furthermore, these plans came alongside reports that other members of the Trump team were drafting proposals to implement political oversight of the Fed’s interest rate decisions. Threats to the Fed’s independence may weaken the dollar over time, but only at the enormous cost of undermining a key institution central to controlling inflation and confidence in U.S. financial markets.
Trump has changed tack and called for the protection of the dollar’s reserve currency by threatening countries that “abandon the dollar” with 100% trade tariffs.
This has led to some confusion, as it appears to contradict plans to prevent dollar exchange rate manipulators from holding huge dollar reserves.
Recent increases in inflation in the United States and Europe relative to Asia have resulted in substantial real appreciation of both the dollar and the euro against Asian currencies.
But if the only sure way to push the dollar down is either by undermining the Fed or by imposing a tax on US asset accumulation abroad, then the whirlwind that could ensue would make the dollar’s appreciation the least of our worries.
