by Matthew Peterson, Chief Wealth Strategist, LPL Financial
§ China looms large at the beginning of 2017 across economic and political fronts; President-elect Donald Trump has suggested branding China a “currency manipulator” as early as his first day in office.
§ China has been depleting its currency reserves to support its economy and its currency, possibly reducing its ability to deal with its growing bad debt problem.
§ The Chinese government does influence the yuan by measuring it against a trade-weighted basket of currencies; the adjustment of this basket creates the appearance of policy changes.
China’s role in the global economy has seldom been more important or controversial. China has been a major producer of global consumer goods for the past 20 years, but at the same time, it has become an important engine of global economic growth. More recently, it has sought to become a major player in global finance. China accumulated a massive reserve of foreign currency, reaching $4 trillion as of June 2014. However, this cache has declined by 25% to just over $3 trillion in December 2016 as the Chinese government sells assets to support the yuan and provide stimulus for its economy. The election of Donald Trump may complicate life even more for Chinese policymakers, as Trump has suggested branding China a “currency manipulator” as early as his first day in office.
The broadly accepted thesis that international trade is intrinsically good for an economy has been rejected. Problems with trade agreements have long been acknowledged. However, it was believed that these problems could be ameliorated by a country internally; say by offering impacted workers retraining, or by finely negotiating terms in the treaty itself. The incoming Trump administration appears to believe that many treaties themselves are flawed. NAFTA is an obvious example. During the September 26 presidential debate he stated that, "NAFTA is the worst trade deal maybe ever signed anywhere, but certainly ever signed in this country," and suggested that NAFTA should be renegotiated.
Trump’s view of trade with China appears to be different. Trump and Peter Navarro, one of his key policy advisors and a professor of economics at the University of California at Irvine, appear to view trade with China in a structurally negative light. Of particular interest is the value of the Chinese yuan. The yuan, which has at times been considered undervalued, has been the source of blame for the trade imbalance between the U.S. and China and the loss of manufacturing jobs.
The value of the yuan has not been constant throughout its history [Figure 1]. After its very limited reintroduction into global commerce in the 1980s, the yuan depreciated from being worth roughly $0.50 in 1984 to being worth around $0.11 by 1994. Ultimately, the Chinese government “pegged” the exchange rate at 8.3 yuan/dollar, making the yuan worth about $0.12 from 1995 to 2005. The U.S. trade deficit in goods increased dramatically during that time, leading many economists, politicians, and corporate executives across the political spectrum to complain that the yuan was undervalued.