Opinion

Is this really a currency war or just a tantrum?

Since the People’s Bank of China (PBOC) allowed the yuan to surpass the dreaded level of 7 to the dollar on August 11, rivers of ink have flowed citing a new matter of contention between the U.S. and China, namely using currencies to gain competitiveness or, more simply, a "currency war."

By: Date: August 28, 2019 Topic: Global Economics & Governance

Previous versions of this opinion piece were published by Forbes and El Pais

El País logo

To describe the events as a currency war may seem logical because another type of “war” between the U.S. and China, namely the trade war, has been on everybody’s mind for the past year and a half. Moreover, the Trump administration itself has continued this game by classifying China as a “manipulator” of its currency immediately after this latest devaluation.

In the same way as the U.S. Treasury is not following its own script when classifying China as a currency manipulator, neither should we think of the yuan mini-devaluation as China initiating a currency war with the U.S. The reason is simple: the yuan–which is not convertible–cannot afford a war with the dollar, nor can the U.S. Federal Reserve control its currency so as to use it as a weapon against China. In other words, neither of the two rivals have the instruments to successfully engage in a currency war against each other.

Starting with the dollar, there is no doubt that its value is determined by the market, as it could not be otherwise being the reserve currency of a world still governed by flexible exchange regimes for major currencies. The Fed can influence the dollar with expansive or restrictive monetary policies, but there are many other factors that it and the Treasury simply cannot control. One important factor is risk aversion: the more the Trump administration tightens the screws on China and, thereby increases the risk of recession globally, the more the dollar appreciates, contrary to what Trump wants.

Moving to the yuan, the PBOC is much closer to determining its value than the Fed can for the dollar, as it retains control on capital flows and does not need to intervene in a highly liquid forex market like that of the dollar. Nevertheless, the reality is that capital is ubiquitous, so capital controls will never be completely effective. In other words, the value of the yuan is not exempt from the forces of demand and supply, nor is its value in the medium term, no matter what the PBOC may opt to do on a specific date or period.

Considering the yuan’s mini-devaluation, the beginning of a currency war is a mistake for one more very important reason. The PBOC has accommodated market pressure by devaluing while central banks tend to move against the market during currency wars. It’s true, though, that the timing of the devaluation could mislead us towards the idea of a China-initiated currency war because it happened right after the U.S. announcement of additional import tariffs on Chinese products. More than a war, we should see this reaction as a tantrum of Chinese policy makers facing additional pressure from the U.S. Besides, as happens for every tantrum, its consequences may not be the desired ones as such mini-devaluation will only prompt more capital outflows from China, undoing part of the monetary stimulus that the Chinese central bank has been carrying out for more than a year to sustain economic growth. In other words, it will not help China to grow, but rather the opposite.

Thus, it is important to distinguish between a war and a tantrum. In the former you control your weapons, in the latter you do not.


Republishing and referencing

Bruegel considers itself a public good and takes no institutional standpoint.

Due to copyright agreements we ask that you kindly email request to republish opinions that have appeared in print to communication@bruegel.org.

View comments
Read article

Blog Post

The EU is in the US trade war crosshairs. It should further raise its game

The incoming European Commission faces a dilemma on the transatlantic trade relationship, because of the unpredictable policies of the Trump administration. The EU must rally its citizens; the greater the divides between member states and EU institutions, the lesser the chances are of forging effective policies toward the United States and China.

By: Anabel González and Nicolas Véron Topic: European Macroeconomics & Governance, Global Economics & Governance Date: September 19, 2019
Read article More on this topic

Opinion

Trump's Backfiring Trade Policy

President Trump’s radical trade policy continues, as do trade disputes with China. The president promised to sign far better trade deals, ensure fair treatment of American firms and reduce the United States’ trade deficit. None of these objectives have been met.

By: Uri Dadush and Laurence Kotlikoff Topic: Global Economics & Governance Date: September 17, 2019
Read article Download PDF More on this topic

Working Paper

EU trade policy amid the China-US clash: caught in the crossfire?

What risks face the EU with regard to China’s strategic aims in trade policy and how can the EU respond? The US effort to isolate China poses particular risks for Europe. How can the EU counter such efforts with the aim of forging its own distinct trade policy? How should the EU move forward with reform of the World Trade Organization (WTO) in light of differing demands and aims of trading blocs like China and the US?

By: Anabel González and Nicolas Véron Topic: Global Economics & Governance Date: September 17, 2019
Read article More on this topic

Opinion

China's dual banking system: consolidation as the final solution for weak small banks

There are fundamental solvency and liquidity issues for some small Chinese banks, widely influencing both the bond market as well as the broader financial sector. Given the difficulties in creating a level playing field between small and large banks, there is an expectation that small banks will continue to under-perform.

By: Alicia García-Herrero and Gary Ng Topic: Finance & Financial Regulation Date: September 16, 2019
Read article More on this topic More by this author

Opinion

The tricky link between the Hong Kong dollar and capital flows

The Hong Kong economy has been hit by a series of shocks, but it should resist taking drastic measures to keep foreign capital in the city.

By: Alicia García-Herrero Topic: Global Economics & Governance Date: September 13, 2019
Read about event

Past Event

Past Event

China-EU investment relations: Exploring competition and industrial policies

This is a closed-door workshop jointly organised by MERICS and Bruegel looking at China-EU investment relations.

Speakers: Miguel Ceballos Barón, Alicia García-Herrero, Mikko Huotari, Yi Huang and Xu Sitao Topic: Finance & Financial Regulation, Global Economics & Governance Location: Bruegel, Rue de la Charité 33, 1210 Brussels Date: September 9, 2019
Read article More on this topic More by this author

Podcast

Podcast

Backstage at BAM19: Enhancing Europe's economic sovereignty

Backstage at the Bruegel Annual Meetings, Nicholas Barrett talks with Jean Pisani-Ferry on Europe's monetary union.

By: The Sound of Economics Topic: European Macroeconomics & Governance Date: September 5, 2019
Read article More on this topic More by this author

Blog Post

Truths about Trade: A speech by Cecilia Malmström

Cecilia Malmström, European Commissioner for Trade, talks on the truths of EU trade at the Bruegel Annual Meetings 2019.

By: Cecilia Malmström Topic: Global Economics & Governance Date: September 4, 2019
Read article More on this topic More by this author

Podcast

Podcast

Backstage at BAM19: Europe's trade policy

Backstage at the Bruegel Annual Meetings, Giuseppe Porcaro talks with André Sapir on European trade policy.

By: The Sound of Economics Topic: Global Economics & Governance Date: September 4, 2019
Read article More on this topic More by this author

Opinion

Why Europe needs a change of mind-set to fend off the risks of recession

Recession! This is the new worry in Europe and the US. A simple look at google trends shows that in Germany, France and the US, search interest for recession peaked in the last weeks. In Italy, the peak already occurred end of January. Whether a recession is actually occurring is difficult to gauge in real time. But there can be no doubt that significant risks such as the trade war and no-deal Brexit exist.

By: Guntram B. Wolff Topic: European Macroeconomics & Governance Date: September 2, 2019
Read article More on this topic More by this author

Opinion

Last Tango In Biarritz: The End Of The G7?

The seemingly omnipotent G7, the meeting of the seven largest developed economies in the world, is weakening continuously and, as the author suggests, this should worry us all.

By: Alicia García-Herrero Topic: Global Economics & Governance Date: August 28, 2019
Read article More on this topic

Blog Post

Hong Kong’s economy is still important to the Mainland, at least financially

Hong Kong’s current situation is important for the world in as far as its role as major offshore financial centre is key for China’s inbound and outbound investment and financing. Capital outflows from Hong Kong are especially risky given Hong Kong's so far useful but rigid monetary regime, namely a peg to the USD under a currency board

By: Alicia García-Herrero and Gary Ng Topic: Global Economics & Governance Date: August 19, 2019
Load more posts