The yuan's sudden slump against the US dollar on Monday added fuel to speculation that China's central bank is allowing currency depreciation to cushion threatened US tariffs.
US President Donald Trump on Thursday threatened new tariffs on Chinese imports as China-US trade tensions spiked again. The sharp fall in the foreign exchange market reflected supply and demand and was a normal market reaction to Trump's latest trade threat.
China has no intention of deliberately depreciating the yuan to spur exports, but Trump's trade war with China has triggered a de facto weakening of the currency and indirectly supported its imports from China.
If Trump further escalates the trade war by imposing more tariffs, the yuan will probably continue to depreciate to ensure a supply-demand balance in the market. The weakness of the yuan can be positive for market discipline and help the currency market develop in a sounder way.
Of course, a gradual depreciation of the yuan will make China's exports more competitive amid the trade war with the US. The by-product of US punitive tariffs will help support China's exports and probably result in a widening trade deficit in the US. In May, the US trade deficit jumped to a five-month high as imports of goods increased, illustrating how Trump's trade war accelerates the US trade imbalance, making it accumulate more trade deficit.
China doesn't want to wage a currency war with the US, in which competitive depreciation will be introduced. However, this doesn't mean Beijing has an obligation to eliminate the side effects of US punitive tariffs by intervening in the market to defend the yuan. If depreciation caused by Trump's punitive tariffs ultimately hits US exports, don't blame China. It's very likely the yuan will continue to depreciate if Trump escalates the trade war.
China's central bank is not the only one that is allowing depreciation amid rising global uncertainty caused by the Trump administration. The euro and some other currencies have also weakened against the US dollar. It's no secret that Trump wants to weaken the US dollar to cut US trade deficit, but his trade policies seem to run contrary to this goal. This situation may force Trump to resort to monetary easing measures to offset the impact of his punitive tariffs on the currency markets and help the US pursue a weaker currency. China will watch closely to see if the Trump administration intervenes in the markets and deliberately weakens the US dollar.
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