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News Europe & Trade

Does a trade war lead to currency wars?

11 Jun 2018

Drawing of people pushing coins of different currenciesJeremy Cook is one of the UK’s leading voices on foreign exchange, following a career that began in the City at HSBC before joining World First in 2007. For his insight, he often appears on television and across the national media, and now holds the post of Chief Economist at World First.

Here for the IoD, Jeremy contemplates the debated correlation between trade wars leading to currency wars…

“Free trade stops wars” was something that I was taught by an economics teacher many a moon ago and advocates of free trade have been keen to express a similar sentiment, both in the atmosphere of the UK’s exit from the European Union and the antagonistic attitude of the Trump administration towards the US’s trade partners and enemies. Trading in an open and aligned manner with another country will foster closer relationships and close relationships don’t typically end up in conflict. My economics teacher didn’t go on to specify what kind of war such free trade arrangements were instrumental in avoiding but for the purpose of this article lets park the notion of China and the US or the UK and the EU turning shipping containers into weapons.

It is also useful to state at the moment that Donald Trump’s White House and President Xi’s Chinese government are not in a trade war and we are not likely to see such an escalation in tensions absent one party having to up the ante to make a political, not economic, point.

There are increased trade tensions between the two countries following President Trump’s rhetoric regarding China’s policy towards its currency and the incorrect belief that running a trade surplus with the United States is an unforgivable crime. These tensions have hardened this year as each party has seen it fit to impose additional tariffs on a number of each other’s goods from steel to soybeans. A lot of these tariffs are merely ‘proposed’ at the moment and therefore are subject to additional time delay and could be negotiated away; they are not affecting businesses yet.

To get an idea of how Trump and his team are set to carry out their plans to “Make America Great Again” and bring China to heel, we can easily read across their negotiating tactics from their decision to fight with Mexico and Canada over the North American Free Trade Agreement. Trump and his trade team of Commerce Secretary Ross, Treasury Secretary Mnuchin and US Trade Representative Lighthizer were bombastic in their demands for fealty in order to trade with the US. Such demands dominated the news cycle, putting the Canadians and Mexicans on the back foot before a softening of the terms revealed how magnanimous the US Administration truly is. I hope you are reading this with the sarcastic tone in which I am attempting to write.

We have our doubts that China will be willing to play this kind of game however and the imposition of tariffs on the import of US grown soybeans – the key staple for Chinese pigs – shows that the Chinese government means business.

With all this going on you would suspect that currency markets would be waxing and waning, we currency guys are simple folk after all. That has not been the case however with FX markets remaining remarkably sanguine about it all.

Volatility remains close to multi-year lows, indicators of investor desire to hedge away a devaluation of the Chinese yuan are low and forward markets that price in a certain amount of future expectations are only pricing in a 1% devaluation.

Close watchers of China and currency markets will know that 2015 saw the Chinese devalue their currency. We assign a very low probability to the chances of them doing so again this year, given they have spent the past three years sorting out the aftermath of the 2015 one and would be worried about Chinese companies and individuals moving money out of the country at a time when they need liquidity.

Who tends to win from a currency war? More likely than not, nobody wins as central banks devalue again and again to obtain some form of competitive advantage over other countries. Businesses have trouble with budgets and margins, consumers see prices of imported goods sky-rocket and exporters rarely benefit from their goods being on sale.

If I were to put my cynical hat on I would have to say that the current trade policy from the US is a useful distraction from Syria, the Mueller investigation, Facebook involvement in Russia, Stormy Daniels and the Midterm elections. While potential Democratic gains in the House and Senate would limit the Administration’s ability to do anything domestically, a lot of trade issues can be acted upon unilaterally from the Oval Office.

We are not in a trade war and we are not in a currency war and for now, conditions are set fair  to remain that way.


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