China Hides Real Trade War Retaliation In Plain Sight – Stealth Devaluation

China Hides Real Trade War Retaliation In Plain Sight – Stealth Devaluation

 

While headlines distract the world’s investors with headlines of Trump and Xi exchanging trade-war shots – with Trump going big with tariff threats ($450bn) and China trying to play ‘good cop’ – something notable has been happening in the FX markets that few are paying attention to.

As we previously noted, there are 6 possible things that China can do at this time, in order of escalating severity:

1. 1. China could de-escalate tensions by presenting a list of actions it will follow to reduce its significant trade deficits in services with the US. This could affect education service institutions, the local tourist industry, and entertainment. However, as the CFR’s Brad Setser writes, it increasingly looks like the Administration is putting China in a position where China cannot make concessions without appearing to cave – which most think China won’t do. Setser, not alone, has trouble seeing a de-escalation option if Trump goes through with the $200b
   2. China will likely launch an economic subsidy for its economy in the form of further easing in financial conditions to offset any potential trade-drag. Some, such as Deutsche Bank have proposed that in order to offset the negative hit to its consumers, China will loosen policy such as tolerating the property and land market boom in tier 3 cities and cutting the RRR twice over the rest of this year to partly offset the potential drags. This would also involve a modest devaluation of the Yuan.

1. China could unleash differential treatment of local enterprises: as some have suggested, Beijing could simply opt not apply its “market access liberalization” policy recently announced. This could greatly disadvantage US firms greatly. Beijing could also engage in an aggressive crackdown on US firms operating in China (Apple), hinder border passage of US products (automotive), or pursue antitrust and monopoly allegations against US tech names (Micron).
2. China could also choose a diplomatic retaliation, and order Kim Jong Un to scuttle the recent agreement North Korea signed with the US, humiliating Trump by showing that it was Beijing all along who made the US-N. Korea summit possible and successful.
3. China could pick an aggressive route, and instead of a mild depreciation, it could aggressively pursue a weaker Yuan to boost trade competitiveness: which, ironically, is the catalyst behind much of the Trump administration’s animosity toward China. To achieve this, China would relaxing some of the capital control measures that have helped strengthen the renminbi in the past 2 years. That said, such a move would unleash sizable outflow demand, while boosting precious metals and cryptos. The US would also brand China a currency manipulator.
4. China, finally, could pick the nuclear option, and gradually or suddenly liquidate its Treasury holdings. This is a long-running worry by markets given China’s $1.2 trillion in Treasury holdings. In January, Bloomberg reported this was a possibility which was at the time denied by China State Administration of Foreign Exchange; however the recent liquidation of half of Russia‘s Treasurys was seen by some as a rehearsal for what would happen if Beijing decides to pursue this approach……more here

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