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THE BOTTOM LINE

China no longer meets criteria for yuan manipulation

Washington

US PRESIDENT Donald Trump sold himself to the American public as an expert deal-maker. At the top of his list was a promised trade bargain with China that would boost US exports and remedy some of the more egregious examples of discrimination against American firms.

It is not working as planned. On the contrary, the ensuing trade war between the United States and China is morphing into something bigger and more ominous. It is increasingly not just a trade war but a broader and more dangerous economic battle, with each nation seemingly determined to hurt the other as much as possible.

What triggered the latest confrontation was Mr Trump's recent decision to slap a 10 per cent tariff on roughly US$300 billion of Chinese exports to the United States. Earlier moves imposed a 25 per cent tariff on US$250 billion of Chinese exports.

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The president's actions reflected his frustration with China's unwillingness to overhaul its trade policies. Instead, according to US officials, China refused to buy more US farm goods. American negotiators have also pushed China to stop forcing US firms to relinquish their latest technologies as the cost of investing in China.

China retaliated by having its central bank - the People's Bank of China (PBOC) - devalue the country's currency. The PBOC had been defending the currency at 6.9 yuan to the US dollar; it moved its target to seven yuan. A cheaper currency would boost China's exports, offsetting some of the effects of Mr Trump's tariffs. The administration reacted by declaring China a "currency manipulator".

Just what happens now is anyone's guess. Start with China's decision to let the yuan go to seven to the US dollar. Ordinarily, this would have been an economic hiccup: a small and not especially important event. Now it has been invested with enormous political significance. Economist Eswar Prasad of Cornell University, a China expert, puts it this way: "(The yuan depreciation) is a clear signal from the Chinese authorities that, from here on, all available covert and overt economic and trade actions are on the table as retaliation against US trade hostilities."

Or take the US decision to label China a "currency manipulator". This sounds tough. It is not. Once the United States labels a country a "manipulator", it must open negotiations with the offending nation. But the US has already been negotiating unsuccessfully for years with China, noted economist C Fred Bergsten of the Peterson Institute. More negotiations do not look promising.

In the past, China clearly manipulated the yuan. Between 2006 and 2014, China spent US$350 billion annually buying US dollars and selling yuan, reports the Institute of International Finance, an industry research and advocacy group. The resulting depreciation of the yuan gave Chinese exporters a huge advantage and made imports into China more expensive.

But now, said Mr Bergsten and other economists, China has stopped using these practices and no longer meets the Treasury Department's criteria for manipulation.

The US law defining currency manipulation sets three tests: First, a significant bilateral trade surplus with the United States. China meets this test; its 2018 goods deficit with the United States was US$419 billion. But it no longer meets the second test, which is persistent intervention in foreign exchange markets, or the third test, which is a large current account surplus with the rest of the world.

Despite this, Mr Bergsten thinks that Mr Trump might use the stigma of being cast as a "currency manipulator" to take further action against China. In the past, he has mentioned imposing a 25 per cent tariff on imported vehicles. Another possibility would be raising existing tariffs from 25 per cent to much higher levels.

The central - and unanswerable - question now is whether we are stumbling towards a larger and unmanageable global economic crisis. There are several possibilities.

One is that the gradual slowing of economic growth in Europe, China and the United States makes it harder for borrowers to service their loans, leading to spending cutbacks or defaults. A related danger is massive capital flight from so-called "emerging market" countries (such as China, India and Brazil), as investors move their funds into safe havens. This, too, would tighten credit.

For the moment, most economists seem to be discounting a devastating crisis. Higher tariffs mean higher prices. They discourage spending and growth, but the amounts affected are modest compared to the size of the US or Chinese economies. Remember that the US economy is roughly US$20 trillion.

What could change the outlook is the impact of the US-China conflict on consumer and business confidence. If people suddenly become more uncertain about the future, the impact on spending could be much larger.

Meanwhile, Mr Trump's self-declared reputation as a great deal-maker is in shambles. It will be hard to make that claim again. WP