How low will the yuan go

China's risky maneuver : That is how dangerous the currency war is

Larry Summers is very concerned about the global economy. "With the latest developments between China and the USA, we could have reached the most dangerous point since the financial crisis in 2009," wrote the US economist on Twitter on Tuesday. The reason for his concern: The trade conflict between the two great powers is also turning into a currency war, the consequences of which could be felt worldwide.

The Chinese sharply devalued the yuan earlier this week. For the first time in eleven years, a dollar cost more than seven yuan. On Tuesday, the Chinese central bank set the yuan's mid-exchange rate a little higher again. The US President Donald Trump accuses the Chinese of "currency manipulation". On Twitter, he railed: "This is a serious violation that will weaken China considerably over time."

The dispute between the USA and China has thus reached a new level of escalation. "This could be the beginning of an irreversible trade conflict between the two countries," said Marcel Fratzscher, head of the German Institute for Economic Research (DIW).

What is behind the devaluation?

Unlike the euro or dollar, whose exchange rate is freely determined on the market through supply and demand, China consciously controls its currency through its central bank. It sets an average rate for the yuan every day, around which it may only deviate upwards or downwards within limits. On Monday, the central bank set this middle rate lower than it has been in years. The mark of seven yuan for one dollar was actually considered the “red line” that the Chinese central bank did not want to cross. Well she did it after all.

This devaluation makes it easier for China to sell its goods abroad because, from the point of view of Americans and Europeans, they become cheaper. In this way, the country can to a certain extent offset the tariffs that are now being levied on goods from China in the USA. Because Trump recently imposed a penalty on more and more imports from the People's Republic in the course of the trade dispute. If Trump keeps his latest announcement, high tariffs could even be due on all goods from China in the USA from next month.

The Chinese have so far responded to this dispute with punitive tariffs. But because the Americans buy far more goods from the People's Republic than they export to China themselves, the Chinese cannot hit them to the same extent. With tariffs alone, they can only exert limited pressure on the USA. The deliberate devaluation of the currency could be a way of countering this.

Are the Chinese manipulating the yuan?

The Chinese reject the charge. The People's Republic has not and will not use the yuan as a weapon in the trade dispute, said the country's central bank. China argues that the country is only reacting to market developments. Chinese economic growth has recently weakened significantly. The weaker yuan rate only reflects this development. The question, however, is whether the Chinese currency will have to devalue so much for this.

The International Monetary Fund (IMF) must now investigate this. US Treasury Secretary Steven Mnuchin has announced that he will be approaching him to "eliminate the unfair competitive advantage" that China has gained. Mnuchin himself is doing a U-turn. In May he refused to officially classify China as a “currency manipulator” and put it on a blacklist. The IMF has always come to the conclusion that China is not manipulating the currency illegally.

How does it go from here?

If one country classifies the other as a "currency manipulator", the two actually have to start talks. In the case of the Americans and Chinese, however, this does not seem to be very effective. After all, they have been negotiating for a year and a half in the wake of the trade dispute, and recent events have made the situation even worse. Klaus Jürgen Gern from the Institute for the World Economy (IfW) fears a "dangerous escalation". The devaluation of the Chinese and the reaction of the Americans indicated that neither side would be willing to back down.

Especially since, in addition to the devaluation of the yuan, the Chinese have also announced that they will stop importing agricultural products from the USA. Gladly considers that a daring step: “The Chinese government risks putting a strain on the domestic economy.” Should the Chinese fail to replace imports from the USA with imports from other countries, food in China would become more expensive or even scarce.

What are the consequences for Germany?

DIW boss Fratzscher fears that other Asian countries could now follow China's example and devalue their currency as well. But that would also affect the euro. Because if other countries devalue, investors shift their money and exchange it for stronger currencies such as the euro. But a strong euro makes German goods more expensive abroad. "The result will probably be lower German exports and thus weaker growth in Germany," says Fratzscher. In addition, German exporters have to hedge more against currency fluctuations. But that costs money and puts an additional burden on German companies.

The local economy is already feeling the trade dispute between the two great powers. Orders from abroad are shrinking for car manufacturers and machine builders. And economist Gern says: "The depressed mood in the industry is now beginning to radiate to other areas of the economy." The fact that imports from China would become cheaper in Germany due to the devaluation is only little consolation.

Now new: We give you 4 weeks of Tagesspiegel Plus! To home page