Why the China-U.S. Trade Conflict Won’t Become a Currency War

The U.S. trade war with China reached a new phase on Aug. 5 after the U.S. labeled China a currency manipulator. That followed a surprise move by the Chinese government to let the yuan break through the long-standing 7-to-1 exchange rate for the first time in 11 years. Tensions eased slightly when China’s central bank fixed the exchange rate a bit higher than the lowest point the yuan hit, but global financial markets remained rattled.

Recent events in the trade dispute have been fast-moving. On Aug. 1 President Trump announced new tariffs on China – 10% on an additional $300 billion in goods — saying China had not bought large amounts of U.S. farm products as promised. Four days later, China devalued the yuan, and the U.S. currency manipulation charge followed. Then on Aug. 6, China said it may increase tariffs on U.S. farm products. But Wharton Dean Geoffrey Garrett explains why U.S.-China dispute is unlikely to become a full-on currency war, in this opinion piece.


Global markets were spooked yesterday by the Chinese Renminbi crossing the psychologically important barrier of 7 RMB to the greenback—sparking speculation that the current trade war will metastasize into a currency war between the world’s two biggest economies. The fact that the Trump administration responded immediately by officially labeling China a “currency manipulator,” for the first time in 25 years, is only grist for the mill.

The logic is straightforward. A weaker Chinese currency cushions the blow to Chinese exports of American tariffs. But greater Chinese exports to America would increase America’s trade deficit within China, creating incentives for the Trump administration to retaliate with a tit-for-tat weakening of the dollar.

Despite this logic, there are three powerful reasons why the trade war won’t become a currency war. In increasing order of importance they are:

1. Donald Trump loves showing America’s strength—and to many, there is no better signal of strength than a strong U.S. dollar.

What’s more, when the global economy wobbles, investors turn to the U.S. dollar as a port in the storm. 

2. The Trump administration cannot unilaterally manipulate the dollar, even if it wants to.

This is true on multiple levels. The dollar floats on global foreign exchange markets without the capital controls that allow a country like China to manage the value of its currency. The single most direct way to weaken the currency is for the central bank to lower interest rates. In the U.S. that is the domain of the Federal Reserve. To Trump’s chagrin, the Fed remains independent of the White House, and its charter asks it to balance the risks of unemployment and inflation, not the exchange rate. And the Fed told the financial markets just last week not to expect further cuts to interest rates.

3. The Chinese government cannot afford the risk of an RMB in free fall.

All the charges by America in the past decade that China is a currency manipulator belie the fact that for more than a decade after 2005, the Chinese currency actually appreciated considerably against the U.S. dollar. This no doubt reduced China’s exports to America, but to China it was worth the price. The specter of mass capital flight has been an existential fear of the Chinese government since the Asian financial crisis in the late 1990s. China then saw the devastating effects of capital flight and vowed that it would never happen in China. With the slowdown of the Chinese economy giving itchy feet to holders of RMB, the last thing China’s government wants is to turn market nervousness into a full-on rush for the exits.

There is no doubt that allowing the RMB to cross 7:1 against the dollar was Xi Jinping’s shot-across-the-bow response to Trump’s threat of imposing tariffs on all Chinese imports on September 1. Just don’t expect the single shot to become an ongoing fusillade.


The Anatomy of the Coming Recession

Unlike the 2008 global financial crisis, which was mostly a large negative aggregate demand shock, the next recession is likely to be caused by permanent negative supply shocks from the Sino-American trade and technology war. And trying to undo the damage through never-ending monetary and fiscal stimulus will not be an option.

Nouriel Roubini

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NEW YORK – There are three negative supply shocks that could trigger a global recession by 2020. All of them reflect political factors affecting international relations, two involve China, and the United States is at the center of each. Moreover, none of them is amenable to the traditional tools of countercyclical macroeconomic policy.

The first potential shock stems from the Sino-American trade and currency war, which escalated earlier this month when US President Donald Trump’s administration threatened additional tariffs on Chinese exports, and formally labeled China a currency manipulator.

The second concerns the slow-brewing cold war between the US and China over technology. In a rivalry that has all the hallmarks of a “Thucydides Trap,” China and America are vying for dominance over the industries of the future: artificial intelligence (AI), robotics, 5G, and so forth. The US has placed the Chinese telecom giant Huawei on an “entity list” reserved for foreign companies deemed to pose a national-security threat. And although Huawei has received temporary exemptions allowing it to continue using US components, the Trump administration this week announced that it was adding an additional 46 Huawei affiliates to the list.

The third major risk concerns oil supplies. Although oil prices have fallen in recent weeks, and a recession triggered by a trade, currency, and tech war would depress energy demand and drive prices lower, America’s confrontation with Iran could have the opposite effect. Should that conflict escalate into a military conflict, global oil prices could spike and bring on a recession, as happened during previous Middle East conflagrations in 1973, 1979, and 1990.

All three of these potential shocks would have a stagflationary effect, increasing the price of imported consumer goods, intermediate inputs, technological components, and energy, while reducing output by disrupting global supply chains.

Worse, the Sino-American conflict is already fueling a broader process of deglobalization, because countries and firms can no longer count on the long-term stability of these integrated value chains. As trade in goods, services, capital, labor, information, data, and technology becomes increasingly balkanized, global production costs will rise across all industries.

Moreover, the trade and currency war and the competition over technology will amplify one another. Consider the case of Huawei, which is currently a global leader in 5G equipment. This technology will soon be the standard form of connectivity for most critical civilian and military infrastructure, not to mention basic consumer goods that are connected through the emerging Internet of Things. The presence of a 5G chip implies that anything from a toaster to a coffee maker could become a listening device. This means that if Huawei is widely perceived as a national-security threat, so would thousands of Chinese consumer-goods exports.

It is easy to imagine how today’s situation could lead to a full-scale implosion of the open global trading system. The question, then, is whether monetary and fiscal policymakers are prepared for a sustained – or even permanent – negative supply shock.

Following the stagflationary shocks of the 1970s, monetary policymakers responded by tightening monetary policy. Today, however, major central banks such as the US Federal Reserve are already pursuing monetary-policy easing, because inflation and inflation expectations remain low. Any inflationary pressure from an oil shock will be perceived by central banks as merely a price-level effect, rather than as a persistent increase in inflation.

Over time, negative supply shocks tend also to become temporary negative demand shocks that reduce both growth and inflation, by depressing consumption and capital expenditures. Indeed, under current conditions, US and global corporate capital spending is severely depressed, owing to uncertainties about the likelihood, severity, and persistence of the three potential shocks.

In fact, with firms in the US, Europe, China, and other parts of Asia having reined in capital expenditures, the global tech, manufacturing, and industrial sector is already in a recession.

The only reason why that hasn’t yet translated into a global slump is that private consumption has remained strong. Should the price of imported goods rise further as a result of any of these negative supply shocks, real (inflation-adjusted) disposable household income growth would take a hit, as would consumer confidence, likely tipping the global economy into a recession.

Given the potential for a negative aggregate demand shock in the short run, central banks are right to ease policy rates. But fiscal policymakers should also be preparing a similar short-term response. A sharp decline in growth and aggregate demand would call for countercyclical fiscal easing to prevent the recession from becoming too severe.

In the medium term, though, the optimal response would not be to accommodate the negative supply shocks, but rather to adjust to them without further easing. After all, the negative supply shocks from a trade and technology war would be more or less permanent, as would the reduction in potential growth. The same applies to Brexit: leaving the European Union will saddle the United Kingdom with a permanent negative supply shock, and thus permanently lower potential growth.

Such shocks cannot be reversed through monetary or fiscal policymaking. Although they can be managed in the short term, attempts to accommodate them permanently would eventually lead to both inflation and inflation expectations rising well above central banks’ targets. In the 1970s, central banks accommodated two major oil shocks. The result was persistently rising inflation and inflation expectations, unsustainable fiscal deficits, and public-debt accumulation.

Finally, there is an important difference between the 2008 global financial crisis and the negative supply shocks that could hit the global economy today. Because the former was mostly a large negative aggregate demand shock that depressed growth and inflation, it was appropriately met with monetary and fiscal stimulus.

But this time, the world would be confronting sustained negative supply shocks that would require a very different kind of policy response over the medium term.

Trying to undo the damage through never-ending monetary and fiscal stimulus will not be a sensible option.


Nouriel Roubini, a professor at NYU’s Stern School of Business and CEO of Roubini Macro Associates, was Senior Economist for International Affairs in the White House’s Council of Economic Advisers during the Clinton Administration. He has worked for the International Monetary Fund, the US Federal Reserve, and the World Bank.

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America has half a million fewer jobs than previously thought

As central bankers meet in Jackson Hole, the Fed ponders its next move



IT IS NOT easy being a central banker these days. Jerome Powell, the chairman of the Federal Reserve, has come under particular scrutiny in recent months. Some commentators believe he has been too hawkish, even though he cut the Fed’s main interest rate by 25 basis points last month, and should cut rates more aggressively. President Donald Trump, who appointed Mr Powell, is now his most vocal critic, and recently tweeted that the Fed should cut its benchmark rate by “at least 100 basis points”.

Lowering interest rates would be a natural response to an economic downturn, but optimists have taken comfort from labour-market figures, which suggest that America’s economy is still humming along. The country’s unemployment rate currently sits at just 3.7%, its lowest level in five decades. The labour-force participation rate of “prime-age” workers aged between 25 and 54, although still below where it was before the financial crisis, has been rising steadily since 2015.

Still, investors are anxious. America’s trade war with China shows no signs of abating. The country’s manufacturing sector is growing at its slowest pace in nearly three years; and business investment contracted in the second quarter. Meanwhile Germany, Europe’s economic powerhouse, appears to be tipping into recession. Recent news from America’s Bureau of Labour Statistics has not helped matters. On August 21st the agency revised its figures, saying that employers added half a million fewer jobs in the year ending March 2019 than previously reported (see chart). The 0.3% downward revision to total non-farm employment was the biggest in a decade.


The bond market is also sending worrying signals. The yield on America’s short-term government bonds currently exceeds that of its longer-term debt. Such “inversions” have preceded each of the past seven recessions. A forecast from the Federal Reserve Bank of New York issued on August 2nd, based on historical data from the government-bond market, estimated that there was a 31% chance of a recession within the next twelve months. Up-to-date data would yield an even scarier forecast. Mr Trump was at one point so concerned that he floated the idea of issuing a new wave of tax cuts, though he appears to have since reconsidered.

All eyes are now on Mr Powell, who is due to speak tomorrow at an annual gathering of central bankers in Jackson Hole, Wyoming. Financial markets currently suggest the Fed has a 98% chance of cutting its benchmark rate by at least 25 basis points by September. Whether such a cut will be enough for Mr Powell to stave off a recession and placate his critics remains to be seen.

The Asian strategic order is dying

Forty years of prosperity in the region are now under threat

Gideon Rachman




When somebody is reaching the end of their life, they often suffer from lots of apparently unrelated ailments — fevers, aches-and-pains, unlucky falls. Something similar may happen when a strategic order is dying. Across east Asia, the past month has seen a rash of diplomatic and security incidents that are symptoms of a wider sickness.

In late July, the Chinese and Russian air forces staged their first ever joint aerial patrol in the region, causing South Korean warplanes to fire hundreds of warning shots at Russian intruders. The South Koreans are also facing the most serious deterioration in their relations with Japan in decades — with the Japanese imposing trade restrictions last week in a dispute that has its origins in the second world war. North Korea has also just restarted missile tests, endangering US-led peace efforts.

All of the other east Asian flashpoints — Taiwan, the South China Sea, Hong Kong and the US-China trade war — are also looking more combustible. Protests and strikes in Hong Kong are still gathering momentum. Chinese officials are now openly discussing military intervention and last week a White House official drew attention to a massing of Chinese troops, just across the border from Hong Kong. For the Trump administration, however, the major preoccupation remains its trade dispute with China, which also intensified last week, with the US imposing a new set of tariffs.

July also saw a Chinese oil exploration vessel enter waters claimed by Vietnam, leading to a stand-off between heavily armed Chinese and Vietnamese ships. The government of the Philippines too sounded the alarm about Chinese naval incursions and called for American assistance. China’s growing assertiveness was underlined by the news that Beijing is developing a military base in Cambodia, its first in south-east Asia.

Tensions over Taiwan continue to rise. In late July a US warship sailed through the Taiwan Strait and China released a defence white paper, accusing the Taiwanese government of pursuing independence and threatening a military response. The US meanwhile is talking of soon deploying intermediate-range missiles in east Asia, following its pullout from the Intermediate-Range Nuclear Forces Treaty last week.

On the surface, many of these incidents seem unconnected. But collectively they point to a regional security order that is coming apart. America’s military pre-eminence and diplomatic predictability can no longer be taken for granted. And China is no longer willing to accept a secondary role in east Asia’s security system. In these new circumstances, other countries — including Russia, Japan and North Korea — are testing the rules.

The past 40 years have been a period of unprecedented growth and prosperity across east Asia, which has also transformed the global economy. But Asia’s economic miracle relied on peace and stability. Those conditions were established in the mid-1970s, with the end of the Vietnam war and America’s rapprochement with China.

Since then, America has tolerated and even facilitated the rise of China. In return, China has tacitly accepted that America would remain the dominant military power in the Asia-Pacific region. You could label these arrangements the “Kissinger order” in east Asia, after Henry Kissinger, the US secretary of state who helped broker the new relationship between America and China in the early 1970s.

But both President Xi Jinping of China and President Donald Trump of the US have rejected basic elements of the Kissinger order. Mr Trump has abandoned the idea that US-Chinese ties are mutually beneficial, by launching his trade war, while Mr Xi has set about challenging America’s strategic pre-eminence.

China’s challenge to American power has raised the question of how long the US’s strategic dominance in Asia will last. Rather than offering reassurance, Mr Trump has added to the uncertainty by openly questioning the value of US alliances with Japan and South Korea. As one Asian foreign minister put it recently: “The damage that Trump has done will outlive Trump.”

The loss of the US’s regional authority is evident in Washington’s inability to control the feud between Japan and South Korea, its two most important regional allies. Even the Australians are beginning to doubt American leadership, with one senior Australian diplomat telling me recently that, with the trade war intensifying, “there will come a point when America and Australia will part company on policy towards China”.

But doubts about American leadership are not matched by any desire to embrace a China-dominated region. On the contrary, from Tokyo to Taipei and from Canberra to Hanoi, there is growing anxiety about Beijing’s behaviour. That anxiety is only increased by the growing closeness between China and Russia. From Moscow’s point of view, the recent joint air patrol underlined Russia’s return as a Pacific power — just as military intervention in Syria signalled its re-emergence as a power in the Middle East.

The Kissinger order in east Asia did not resolve most of the historic disputes and rivalries in the region. But it helped to freeze regional conflicts in place, buying time for peaceful development. Now the geopolitical climate has changed so frozen conflicts are moving again. As the ice melts, things can move fast in dangerous and unpredictable ways.


Officials See Few Options if Slowdown Hits

Amid debate over whether the U.S. is going into an economic downturn, there are few good options to deal with one if it happens

By Rebecca Ballhaus and Nick Timiraos


Policy makers have limited options to boost the U.S. economy amid signs it is slowing. Above, a Mercedes-Benz assembly plant in Vance, Ala. Photo: andrew caballero-reynolds/Agence France-Presse/Getty Images


After debating for days whether the U.S. is going into an economic downturn, Washington policy makers and Wall Street investors on Wednesday barreled into an even more difficult problem: There are few good options to deal with one if it happens.

With short-term interest rates already low, the Federal Reserve has little room to cut borrowing costs to spur spending and investment as it usually does in a slowdown. Meantime, the federal debt is exploding, which could hamstring any efforts to boost growth with tax cuts or spending increases.

Further complicating matters, Democrats and Republicans strongly disagree about how best to rev up the economy, with Democrats favoring higher spending and the GOP wanting lower taxes. Even within their own ranks there are disagreements about what course to take.

President Trump on Wednesday backed away from pursuing new tax cuts, a sharp reversal from a day earlier, when he described several such measures the White House was contemplating. Mr. Trump is in the awkward position of calling for economic stimulus at the same time he says the economy is strong.

“I just don’t see any reason to,” Mr. Trump told reporters at the White House when asked if he was contemplating tax cuts. “We don’t need it. We have a strong economy.”

He dismissed an idea he floated Tuesday: lowering capital-gains taxes by indexing investment gains to inflation. “I’m not looking to do indexing,” he said. “I think it will be perceived, if I do it, as somewhat elitist…I want tax cuts for the middle class, the workers.” He added that it was an option, but “not something I love.”

On Tuesday, speaking to reporters in the Oval Office, the president said he had been “thinking about payroll taxes for a long time” and that indexing was “something I’m thinking about.” He added, “I would love to do something on capital gains.”

White House officials, meanwhile, said the administration has long been examining a range of tax cuts as part of what Republicans have termed “Tax Cuts 2.0,” though no proposals are expected imminently and such a measure is unlikely to go anywhere in Congress.

The president also has been pressuring the Federal Reserve to cut interest rates at a clip typically only seen when the economy is severely struggling. On Wednesday morning, Mr. Trump compared Fed ChairmanJerome Powell,his own choice for the post, to a “golfer who can’t putt.”

Though unemployment remains exceptionally low, economic growth and hiring have slowed in recent months and some warning signs are flashing in bond markets. Most notably, long-term interest rates at times have dipped below short-term rates, something that has telegraphed recessions in the past and spooked investors in recent weeks.

Wednesday’s economic reports included some troubling new signs. U.S. job growth was weaker in the year through March than previously thought, government economists said. The Labor Department lowered its estimate of total U.S. employment in March by 501,000, or 0.3%. That brought down the average monthly increase in payrolls over the period to about 168,000 from 210,000—still solid but not as robust as once thought.

Other government data revisions in recent weeks also pushed down estimates of growth and corporate profits.

But it wasn’t all bad news: Sales of previously owned homes picked up in July, the National Association of Realtors said Wednesday, a sign that lower mortgage rates may be driving sales after a weak spring selling season. Some retailers also reported good profit numbers, another sign that households remain a pillar of the economy.

The Dow Jones Industrial Average rose 240.29 points Wednesday, or 0.93%, to 26202.73. It had surpassed 27000 in July, when downturn worries started to concern investors.

Academic research cited by top Fed officials in the past says that the central bank should move quickly to cut short-term rates in moments when it has little room to maneuver and the economy might be heading for a slide.

The Fed’s target rate is just over 2%, leaving far less room to cut aggressively than in the past.

But officials at the central bank aren’t yet convinced that drastic action is needed. Moreover, the Fed’s ranks are divided about what steps to take.

Fed minutes from its July 30-31 meeting released Wednesday showed several officials favored holding rates steady because they judged “that the real economy continued to be in a good place.”

Two of those officials, Boston Fed President Eric Rosengren and Kansas City Fed PresidentEsther George,dissented from the decision to cut rates by a quarter percentage point.

But two other officials, not identified in the minutes, favored a more aggressive half-point cut, which they said would better address “stubbornly low” inflation.

The minutes also showed the officials believed uncertainty surrounding the Trump administration’s trade policy wasn’t likely to let up anytime soon, creating a “persistent headwind” for the U.S. economic outlook.

Many business executives have said the uncertain outlook for U.S. trade policy could be holding back the economy. With the U.S. locked in sharp disagreements with China over a range of issues, that might not get resolved soon.

Mr. Powell disappointed some investors—and the president—at his news conference after the July meeting when he pushed back against market expectations of a more vigorous series of rate cuts to follow.

“Now we know why Powell had a hard time at the press conference. There wasn’t a clear consensus,” saidDiane Swonk,chief economist at Grant Thornton.

Washington’s appetite for budget deficits could be tested by a slowdown or recession. Federal spending tends to rise in a recession because mandatory payments on programs like unemployment insurance goes up. Meantime, tax receipts tend to slow as household income growth and business profits slow or decline.

On top of all of that, cutting taxes or increasing spending to kick-start growth could be a challenge since both can boost deficits. Federal deficits are projected to grow much more than expected over the next decade thanks to the two-year budget agreement lawmakers and the White House struck last month, the Congressional Budget Office said Wednesday.

The agency boosted its forecast of cumulative deficits over the next decade by $809 billion, to $12.2 trillion. That means an additional $12 trillion of debt on top of the $22 trillion already outstanding.

The increase primarily reflects higher federal spending under the new budget deal, partly offset by lower projected interest rates.

The CBO said the new agreement, which increased spending roughly $320 billion over the next two years above previously enacted spending caps, will add roughly $1.7 trillion to deficits between 2020 and 2029. That reflects CBO’s assumption that federal spending will continue to grow at the rate of inflation after 2021.

Deficits as a share of gross domestic product are expected to average 4.7% over the next decade, up from the 4.3% average CBO projected in May, and a significant increase from the 2.9% average over the past 50 years.


—Kate Davidson, Josh Mitchell and Alex Leary contributed to this article.