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China Strikes Back: Stocks, Soybeans, and Currency

AngelaRoberts

Written by Angela Roberts

Aug 8, 2019

“We may well be at the most dangerous financial moment since the 2009 Financial Crisis with current developments between the U.S. and China.”

–Former Treasury Secretary Larry Summers

China’s move to devalue its currency sent markets reeling and gold soaring on Monday. The People’s Bank of China said the devaluation was “due to the effects of unilateralist and trade-protectionist measures and the expectation for imposition of tariffs against China.” The central bank allowed its currency to slip below the politically symbolic “seven yuan to a dollar” range—its weakest level in more than a decade.

A devalued yuan makes China’s exports less expensive and more attractive to buyers around the world. While this could help offset the sting of U.S. tariffs, it could also upend the global economy at a very precarious time.

And Beijing didn’t stop there. It also ordered state-owned companies to stop purchasing U.S. agricultural products, particularly soybeans produced in the American heartland where Iowa, Illinois, Minnesota, and Indiana are among the top-producing states.

China was once the largest buyer of American soybeans, but their imports have fallen by 97% since the start of the trade war some 16 months ago.

China’s retaliation came after President Trump’s announcement that the U.S. will move forward with a 10% tariff on an additional $300 billion of Chinese goods. These developments sent stocks plummeting on Monday. The Dow cratered more than 760 points, the S&P 500 sunk more than 87 points, and the Nasdaq tumbled more than 270 points—for respective losses of 2.9%, 2.98%, and 3.47%.

President Trump raised the temperature further by tweeting, “China dropped the price of their currency to an almost a historic low. It’s called ‘currency manipulation.’ Are you listening Federal Reserve? This is a major violation which will greatly weaken China over time!”

Currency manipulation is prohibited by the International Monetary Fund, which China helped co-found in 1945. Article IV, which went into effect in 1978, states that:

“Countries should seek, in their foreign exchange and monetary policies, to promote orderly economic growth and financial stability, and they should avoid manipulation of exchange rates or the international monetary system to prevent effective balance of payments adjustment or to gain unfair competitive advantage over other members.”

When a country weakens its foreign exchange rates against the dollar to improve their competitive position—as China has done—it sounds like “manipulation.” And when that country creates trade surpluses to boost domestic factory production and job growth, it clearly looks like an attempt to “gain an unfair competitive advantage.”

Julian Evans-Pritchard, a senior China economist at Capital Economics, minces few words in summarizing China’s recent currency actions, stating that the People’s Bank “has effectively weaponized the exchange rate” and significantly raised the stakes for global collateral damage.

C. Fred Bergsten, a senior fellow at the Peterson Institute for International Economics, maintains, “Currency manipulation is, by far, the world’s most protectionist international economic policy in the 21st century, but neither the U.S. government nor the responsible international institutions, the International Monetary Fund and the World Trade Organization, have mounted effective responses.” Bergsten adds that the practice directly contributed to catastrophic job loss during the Great Recession and continues to cost the United States hundreds of billions of dollars each year.

Currency manipulation, however, is a zero-sum game with no real victor. It can fuel inflation, suppress growth, and dangerously distort economic cues. And a flood of cheap Chinese goods dumped into the global marketplace will undercut smaller exporting nations like Vietnam, Indonesia, and Bangladesh. This will not only upset the macroeconomic landscape, but also rattle the global financial system.

So as this ongoing clash of the economic titans continues to play out, one thing is clear: China is more than capable of punching back. But what’s more worrisome is the rising intensity, increasing retaliatory sentiment, and utilization of measures once deemed off limits.

Chris Krueger, managing director of Cowen Washington Research Group, stated on Monday that “the next stop on the currency manipulation road is probably off the map” and predicted “more tariffs, investment restrictions, and export controls.”

Indeed, a trade war coupled with a retributive currency war will slam equity markets and dramatically destabilize the world economy.

So trade wars are “not good”—as President Trump suggested in the early days of the dispute—nor are they “easy to win.” China appears to be digging in for a long conflict and seems far more willing to await the outcome of the 2020 election than to offer up any concessions to the current U.S. President.

So where will Wall Street be by fall next year? What kind of hit could your portfolio take? And what are you doing to protect your assets?
Gold is enjoying a six-year high, and as tariffs and tensions escalate, it continues to be a safe haven of choice for those looking to preserve their wealth, protect their retirement, and be on the right side of economic history.

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