China Eyes Yuan Devaluation in Trade Dispute

Finally, we have a story that makes retaliatory sense vs. the widely believed "nuclear" treasury dumping theory.

The widely-circulated "nuclear" theory suggests China would dump US treasuries in a trade war with the US. That theory never made any sense. Such a move would tend to strengthen the yuan, making Chinese exports more expensive. Thus, it would be precisely what the US would want.

The Real Nuclear Option

The real nuclear option would be a devaluation of the yuan, making Chinese goods less expensive to the US.

China is evaluating the potential impact of a gradual yuan depreciation, people familiar with the matter said, as the country’s leaders weigh their options in a trade spat with U.S. President Donald Trump that has roiled financial markets worldwide.

Senior Chinese officials are studying a two-pronged analysis of the yuan that was prepared by the government, the people said. One part looks at the effect of using the currency as a tool in trade negotiations with the U.S., while a second part examines what would happen if China devalues the yuan to offset the impact of any trade deal that curbs exports.

While a weaker yuan could help President Xi Jinping shore up China’s export industries in the event of widespread tariffs in the U.S., a devaluation comes with plenty of risks. It would encourage Trump to follow through on his threat to brand China a currency manipulator, make it more difficult for Chinese companies to service their mountain of offshore debt, and undermine recent efforts by the government to move toward a more market-oriented exchange rate system.

It would also expose China to the risk of heightened financial-market volatility, something authorities have worked hard to avoid in recent years. When China unexpectedly devalued the yuan by about 2 percent in August 2015, the move fueled capital outflows and sent shock-waves through global markets.

Nuclear Option Risks

Clearly, there are risks of devaluation. But China can mitigate much of those risks with a controlled, slow devaluation instead of multi-percent move as we saw in 2015.

Brad Sester echoes sentiment I expressed previously regarding the alleged "nuclear" dumping option.

Five days ago, I stated "It's highly unlikely China would dump US treasuries in a trade war. Yet, the talk surfaces all the time."

It's amusing how ass backward the "nuclear" proponents were. A devaluation, not dumping treasuries, is the real nuclear option.

Mike "Mish" Shedlock

If they devalue the Yuan, they'll have to buy more USD debt. I wonder how that would play out politically. I guess they could always do it via proxies and deny doing it.

"Dumping" Treasury bonds simply means moving dollars back into their reserves. Those dollars would be worth more against the yuan, but not by as much as they would lose in the transactions. Purchasing less Treasury debt means making less on their dollar holdings, so the tradeoff isn't as cut a dried as most want to view it. They don't "purchase" dollars. They get them because we want to buy their cheap goods and we pay for them with paper that we mostly pull out of our backsides at will. As long as the US debt is denominated in the currency it creates by fiat there is no risk to holders of our debt, or to us. Cheaper goods mean more US sales or higher profits. The dollars moved back and forth between reserves and Treasury are moot because we don't need to sell debt to fund anything.

Is China's currencu still pegged to the dollar?

Interesting. Normally if the US put a tariff on goods from China, American consumers would pay for in in terms of higher prices and a lowered standard of living. If China devalues their currency to offset the tariff, American consumers are unharmed since prices would stay the same. Instead, Chinese consumers would be harmed when all goods they buy from anywhere overseas would rise in price.

AH SO! Now I recognize them: Merchantilist currency manipulators. I doubt they'll try this again so soon after the debacle in January 1994. They arbitrarily devalued 33% and destroyed their Asian trading partners. Too many eyes on them at the moment to set off a blatant currency race to the bottom I think.

China devaluation makes sense respective to their low imports to export ratio. China should first increase import buying using US treasuries, build significant inventory THEN devalue and sell the products to US at lower prices offsetting tariffs.

No matter what the Chinese do, any trade war actions will hurt China as well as the US. That’s why it is all so ridiculous. China doesn’t want any part of it, but they also do not want to be bullied by Trump. Trump has started a dangerous game.

They can't hold US dollars in currency. The money they accumulate in USD has to go somewhere. They can't put it in a bank deposit since it would need to be converted to Yuan first which would negate the purpose of buying USD in the first place. They have to buy something in the US and the only thing that the US gov't will allow them to spend hundreds of billions on is debt.

One of the most important things to remember about the global currency system is that by design it is fairly closed. This means relative value tends to merely shift back and forth between the four major currencies that dominate the system, this is the main reason currencies appear more stable than they really are.

It only becomes a real problem for governments to deceive us as to the real value of our currency when this bond is broken. Unstable currency markets can be a precursor to massive shifts in value and a sudden drop in confidence. It is logical to think that in such a situation insiders would be the big winners. More on this subject in the article below.