Trump’s China battle heads into the danger zone

President Donald Trump is pushing his bitter trade war with China into an aggressive and unpredictable new phase, bewildering Wall Street and risking an even bigger slowdown heading into a 2020 election in which the economy was supposed to be the president’s strongest selling point.

The Trump administration on Monday evening drove the stand-off with the world’s second-largest economy to a new level, officially labeling China a currency manipulator for the first time in a quarter century, enraging Beijing and inviting further retaliation in a bare-knuckled fight that has already slammed U.S. farmers and helped drive American manufacturing close — or into — recession.

Following a precipitous stock-market decline that started the week, investors on Tuesday took a break after China intervened to keep its currency, the yuan, from plunging further. But traders and money managers said market turmoil could resume at any moment given the unpredictable nature of the American president and the enormous stakes involved in such a titanic showdown.

“I think the expectation is that this is going to escalate and get worse rather than coming to a place of agreement or just going away,” said Putri Pascualy, managing director at investment firm PAAMCO Prisma. “The risk in the market is political and political risk for investors is very difficult to handicap.”

For the moment, advisers inside the White House who are urging a calm, methodical approach to China — one that favors engagement over escalation — appear to be losing out. The Treasury Department, under Steven Mnuchin‘s leadership as secretary, declined multiple earlier opportunities to label China a currency manipulator despite Trump’s campaign pledge to do so on day one.

That changed on Monday after Beijing allowed the yuan to devalue beyond 7 to the dollar, a psychologically important level. That move followed Trump’s pledge last week to slap 10 percent tariffs on all Chinese exports to the U.S. not currently covered by existing tariffs, a list that includes mostly consumer goods like iPhones and clothing. The tariffs could hit during the holiday shopping season. 

Treasury announced the decision without any public comment by Mnuchin. Treasury declined to make officials available to discuss the decision. One question among investors was why Treasury moved now even though the yuan’s decline appeared to be the result of market forces and a lack of government intervention. 

In June, the International Monetary Fund said China’s currency “is not overvalued nor undervalued.” And China appears to satisfy only one of the three U.S. criteria for being labeled a currency manipulator. Those include a significant bilateral trade surplus with the U.S., which it has, a material current account surplus over 3 percent of GDP and persistent one-sided intervention in its currency market, both of which it does not. 

Larry Summers, Treasury Secretary under President Bill Clinton, wrote in a Washington Post op-ed that China does not currently meet the criteria to be labeled a manipulator. “Its interventions in currency markets over the past several years have been to prop up its currency rather than to drive it down,” he wrote.

A person close to the decision said the Trump administration’s move was made not based on one Chinese action but in the context of all its behavior and public statements on its currency.

Mnuchin made the decision in consultation with Trump, this person said, using the 1988 Omnibus Trade and Competitiveness Act addressing countries that "manipulate the rate of exchange between their currency and the United States dollar for purposes of preventing effective balance of payments adjustments or gaining unfair competitive advantage in international trade." The multiple criteria are included in the more recent 2015 Trade Enforcement Act. 

Gary Hufbauer, a senior fellow at the Peterson Institute for International Economics, said the Trump administration appears to have added a new criteria to the Treasury Department’s definition of currency manipulation in order to cite China.

Basically, Treasury concluded the People’s Bank of China was guilty of manipulation because it didn’t intervene to support the currency, even though it had “plenty of cash on hand,” Hufbauer said. “That’s a new criteria, just kind of invented overnight.”

Hufbauer, who served in the Treasury Department in the late 1970s, doubted the IMF would conclude China’s recent actions would amount to currency manipulation under Article IV of the organization’s charter.

Publicly, White House officials including National Economic Council Director Larry Kudlow described a united front in the West Wing, despite weeks of internal battles over how hard to push the trade war as the economy cools and reelection approaches. 

“What I will say is the trade team, including myself, stands 100 percent behind President Trump,” Kudlow said Tuesday on CNBC. “At some point in time, if they are violating our laws, WTO laws, and frankly G-20 laws of currency stability, we have to take the action. We just have to.” 

Closer observers of White House China policy said they believed the decision to label China a manipulator likely came directly from the president — who labeled China a currency manipulator in his own tweets. “He didn’t need anyone to convince him it was a good idea. He was looking for an excuse,” said Derek Scissors, a China expert at the American Enterprise Institute who has advised the administration.

“The president getting angry at China in mid-July mattered,” he said. 

Trump wanted to announce the 10 percent tariffs earlier last month. Advisers including Kudlow and Mnuchin talked him out of it, arguing that he should wait until after talks in Shanghai. When those talks did not produce enough movement to satisfy Trump, he tweeted out the new tariff threats last week. 

One former senior White House official described the currency manipulator decision as a quick-trigger response following weeks of frustration by Trump that China wasn’t moving faster to buy American agricultural products or crack down on sales of the widely abused pain medication fentanyl. “I’m sure it was spontaneous even though there are defined rules” on how to make such a determination, the former official said. 

The main concern among some of Trump’s aides is that a spiraling trade war with China will both undermine the president’s beloved stock market gains, further chill corporate investment and anger red-state farmers who have seen their exports of soybeans and other agricultural products to China plunge.

The Dow Jones Industrial Average, which recovered somewhat on Tuesday after a nearly 800-point decline on Monday, remains below where it was in January 2018 before the trade fights began in earnest. The Standard & Poor’s 500 is also around where it was 18 months ago. 

The market has essentially embraced nothing Trump has done since signing a major corporate tax cut in late 2017. And Trump himself raged over sharp market declines last December, ripping the Federal Reserve as the culprit on Twitter and sending advisers out to try to calm investors.

The real economy is also suffering, though for now consumers remain in strong shape. Manufacturing as measured by the Federal Reserve has declined for two straight quarters, the technical definition of recession, in large part due to higher input costs based on Trump’s tariffs and uncertainty among businesses about what tariffs might come next and how China might respond. 

Economic growth in the second quarter slowed to 2.1 percent with gross private domestic investment plunging an alarming 5.5 percent. Another worrisome signal came this week when a reading on non-manufacturing, which covers most of the economy, came in lower than expected and at the worst level in three years. 

Farmers, a key constituency for the White House, are showing increasing frustration with Trump’s inability to strike a deal with Chinese President Xi Jinping. China reportedly halted agricultural purchases after Trump’s latest tariff threat. Farm exports to China dropped to $7.5 billion in 2018 from $16.2 billion in 2017, according to RBC Capital Markets, and are now set to fall further. 

“China’s announcement that it will not buy any agricultural products from the United States is a body blow to thousands of farmers and ranchers who are already struggling to get by,” Zippy Duvall, president of the American Farm Bureau Federation, said in a statement Monday. 

Trump’s more hawkish trade advisers are mostly dismissing Wall Street reaction and rejecting the idea that Trump’s trade fight — which they say is the only way to stop Chinese trade cheating — will derail the economy. 

Senior trade adviser Peter Navarro on Monday called the sell-off a “massive overreaction” and urged calm. “We have a very solid economy. The stock market should be a leading indicator of that economy,” he said on Fox Business. He then attacked Wall Street. “Goldman Sachs, they’re the commander in chief on Wall Street of off-shoring. Full stop.”

Goldman Sachs, for its part, is now predicting there will be no trade deal with China before the 2020 election. And it said the Fed will be forced into cutting interest rates twice more this year, in both September and October, to fight off the impact of Trump’s trade battles. 

At the moment, Wall Street investors see no end to the China tensions in sight, though some hope for a Trump-Xi phone call that could ease tensions.

One issue could provide a potential off ramp: U.S. treatment of blacklisted Chinese telecommunications giant Huawei. The company has emerged as a global competitor on next generation 5G technology and is highly valued by Beijing.

The Commerce Department is still considering whether to grant licenses that would allow major U.S. companies to sell microchips and other components that don’t pose a national security risk to the smartphone maker. By Aug. 19, Commerce must also determine whether it will extend a broader waiver that allowed other certain transactions between Huawei and U.S. firms. An industry source said Commerce is telling companies that export licenses for Huawei could be issued as soon as this week.

Scissors said he could see a situation in which the U.S. grants some of those waivers to give Huawei a reprieve. That could push Xi to act on fentanyl or resume agriculture purchases. “Trump doesn’t care about Huawei,” he said. “He wouldn’t see granting licenses as a weakness.”

For now, the currency manipulation charge requires consultation with the IMF about potential remedies. And that could go nowhere. 

“This is not going to pass muster at the IMF. It’s not an intervention by China with an attempt to get an unfair advantage in export markets. That’s not what happened. What happened is the market drove the RMB down, thanks to the threat of a new round of tariffs," Hufbauer said. 

It’s possible the United States might hold up a vote on the European Union’s nominee, World Bank chief executive Kristalina Georgieva of Bulgaria, to be the next IMF managing director “until it gets assurances that somehow the knuckles of the Chinese will be rapped,” Hufbauer said. 

Otherwise, it's likely the U.S. action could disappear in the IMF bureaucracy, never to be heard from again, Hufbauer said. That's particularly true if China keeps its currency from depreciating significantly below 7 yuan to the dollar to ease tensions with the U.S.

Source: Politico