Foreign exchange risk possibly transmitted by Sino US trade friction

Just half a month ago, with the signing of the Free Trade Agreement between the European Union and Japan, as well as the release of the Joint Declaration between the European Union and the United States, the trade war between developed countries was embedded in a pause, but the trade pressure faced by China was escalating. An important part of the Joint Declaration between Europe and the United States was that both sides agreed to work together to solve China's market abuse problem; On August 2nd, the US Trade Representative announced that the proposed tariff rate for Chinese goods worth $200 billion would be increased from 10% to 25%. The following day, China announced countermeasures: four levels of differentiated tariffs would be imposed on US goods worth approximately $60 billion, with 5207 tax items originating from the United States. The impact of changes in trade policies on the economic landscape of the two countries has already caused subtle adjustments in the monetary and industrial fields, and may change the future direction of trade conflicts.
High tariffs make US policies begin to contradict themselves
The two rounds of continuous expansion of tariff barriers between China and the United States have plunged the United States into a trap of conflicting policies:
Firstly, trade policy is opposed to monetary policy. The long-term low tariffs in the United States are the basis for the Trump administration's desire to increase tariffs and reduce the trade deficit. As the world's largest importer, the United States has long implemented a system of general preferences for most imported products. In 2016, the average import tariff rate of the United States was only about 1.7%, of which the tariff rate for primary products was about 3.6%. China is the second largest source of imports for the United States, with goods from China accounting for 18% of the total imports from the United States in 2017. In this batch of $200 billion taxable goods, 23% were consumer goods such as telephones, computers, and furniture (while in the previous batch of $50 billion taxable goods, only 1% were consumer goods), which will increase the living expenses of American consumers; Another 77% are mainly intermediate inputs and capital equipment, which will increase the production costs of American enterprises and reduce their profits. The simultaneous rise of CPI and PPI is likely to push up the mid-term inflation target of over 2% in the United States, prompting the Federal Reserve to increase interest rates and further appreciate the US dollar. Under the international trade that follows a market economy, a strong US dollar is clearly not conducive to narrowing the US trade deficit. If the Federal Reserve keeps the interest rate unchanged, it will also be detrimental to the continuous growth of the U.S. economy - the U.S. stock market has hit a 15 year historical high this year, and the foam may reappear. This puts the White House's trade policy in opposition to the Federal Reserve's monetary policy.
Secondly, trade policies are in opposition to industrial policies. Faced with the global consumer market, American multinational corporations can only further invest in green space through FDI and directly build factories for production and sales in order to maintain their share and adopt tariff countermeasures in trading partner countries. In addition to large American manufacturers such as Harley Motors and Zhongzhou Iron Nails, which decided to transfer some production lines overseas, Tesla also established its first overseas Ultimate Factories in Shanghai against the background of China's continuous introduction of Glasnost in the financial services industry and significant improvement in the business environment. Obviously, what the tariff stick brings to Made in USA is not "return" but "exit". It can be inferred that this series of strikes has a significant impact on the compromise between the United States and the European Union - suspending the imposition of new tariffs on the EU (including a plan to impose a 25% tariff on imported cars), and negotiations will be held on the issue of steel and aluminum tariffs on the EU. Obviously, the trade threat by means of high tariffs is only a short-term means of protecting domestic industries, and industrial development ultimately depends on the regulation of industrial policies (investment policies).
It can be seen that the current Trump administration's trade protectionism policy of raising tariff barriers does not align with the direction of the Federal Reserve's monetary policy, and also conflicts with industrial policies that hope for a return of manufacturing. This provides an opportunity for short-term negotiations to reconcile trade conflicts between China and the United States.
Trade conflicts may transform into monetary and financial conflicts
However, if the space for trade means is limited, the United States is likely to further adopt exchange rate measures to achieve policy goals, leading to a trade conflict between China and the United States evolving into a conflict in the monetary and financial fields. This is because monetary policy is more effective than trade policy. The "effectiveness" of policies is mainly determined by two indicators. Firstly, how independent are government agencies? Secondly, how effective is the implementation of policy tools? When an economic policy tool can affect other countries' foreign economic policies or even foreign economic strategies, or cause changes in the pattern of the international financial market, then this policy tool is effective.
For the first indicator, it is only necessary to observe which policy implementation department is more independent. The Ministry of Commerce regulates trade variables, while the Ministry of Finance and the Central Bank regulate monetary variables. Obviously, the Ministry of Finance and the Central Bank are more independent than the Ministry of Commerce. Because the autonomy of trade policies is often subject to interference from domestic interest groups: industrial sectors that compete with imports are often protectionist, while export-oriented sectors support free trade, and their preferences influence national decision-making through politicians.
For the second indicator, in the era of financial capital globalization, the government's adoption of financial policy tools is more effective than trade policy tools. On the one hand, because the object of financial policy is not inventory goods, but capital, which flows globally. That is to say, financial policies themselves deepen global interdependence and are naturally more effective than trade policies. On the other hand, the government's use of financial policy tools clearly has more informal operational space than adopting foreign trade policies. A government is an important provider and demander of funds in the international financial market. For example, the Ministry of Finance can issue treasury bond in the offshore financial market, conduct global financing, or conduct global investment through sovereign funds according to the financial situation of the home country; The autonomy of trade policies will be strictly constrained by the WTO and bilateral trade agreements.
China needs to carefully adjust its exchange rate policy
Although neither China nor the United States has yet planned to resolve trade issues through exchange rate measures, the fact is that the spillover of trade conflict policies has already begun, prompting both sides to use monetary and exchange rate tools to influence trade conflicts.
Since April, the Chinese yuan basket index has continued to decline by nearly 7000 points, setting a historical record. Among them, the exchange rate against the US dollar has dropped from 6.2 to around 6.9, and breaking the "7" mark is within reach. Faced with the rapid depreciation of the renminbi in the short term, the People's Bank of China has decided to adjust the foreign exchange risk reserve ratio for forward foreign exchange sales from 0 to 20% starting from August 6th. In essence, this mechanism is a "Tobin tax", which alleviates the exchange rate instability caused by the rapid expansion of short-term speculative funds by "throwing sand into the wheel of the rapidly operating international financial market". Affected by the "811" exchange rate reform, the central bank activated this mechanism during the sharp depreciation of the RMB in September 2015, and two years later lowered the reserve requirement to zero. The current increase in the reserve requirement ratio is conducive to smoothing out the pro cyclical fluctuations in the foreign exchange market and also helps to suppress the rebound sentiment in the United States triggered by rapid depreciation.
Looking at the United States again. At the beginning of this year, based on the judgment that the US economy maintains strong growth and the job market continues to strengthen, the Federal Reserve said that it will raise interest rates four times this year, which has made the U.S. Dollar Index continue to strengthen this year. The Federal Reserve has independent monetary policy making power, but on July 19th, Trump publicly criticized the Federal Reserve's interest rate hike policy for deteriorating US export conditions; On August 1st, the Federal Reserve decided to keep interest rates unchanged. Although it cannot be proven that there is a causal relationship between the two, it is not without history to follow. As early as 1965, in order to open loose credit to finance the Vietnam War and the "Great Society" program, then US President Johnson summoned Martin, then chairman of the Federal Reserve, at his Texas farm, and asked the Federal Reserve to cut interest rates again to support his policy; In the 1970s, then President Nixon put pressure on the Federal Reserve to postpone interest rate hikes until after the 1972 election; In April 2016, former President Obama and then Federal Reserve Chairman Yellen held a private meeting behind closed doors, triggering a fierce reaction in the market. In addition, in terms of Trump's own style, intervening in the independence of the Federal Reserve through public opinion is not surprising - during the 2016 presidential campaign, Trump criticized Yellen for playing politics and helping Democratic presidential candidate Hillary Clinton win by keeping interest rates low; After Trump took office, he replaced Yellen with Powell, breaking the tradition of re serving as the chairman of the Federal Reserve.
The advantage of the US dollar in various functions of the international currency far exceeds that of the Chinese yuan, and the US Treasury and Federal Reserve have much more operational space in the international financial market than China. The current US government has not yet put pressure on China regarding the exchange rate issue, and the continuous depreciation of the RMB is mainly due to the market behavior of international capital. The People's Bank of China has raised the foreign exchange risk reserve ratio for forward foreign exchange sales this time, and may further add countercyclical factors to regulate the RMB basket index in the future. Whether it is an increase or a decrease, and what level is the reasonable equilibrium level of the RMB exchange rate, China needs to carefully adjust its exchange rate policy to prevent the trade conflict between China and the United States from eventually evolving into a conflict in the monetary and financial fields.