US-China trade talks will focus on yuan weakness, experts say

The Chinese yuan’s weakness will be a focal point during the U.S.-China trade talks in late August, as both countries grapple with the fallout from recent fluctuations in the currency markets, analysts said.

The mid-level talks will likely be about “how exactly are they going to deal with the RMB (renminbi),” said Robin Brooks, chief economist at the Institute of International Finance, referring to another name for the yuan.

On Friday morning in Asia, the dollar traded around 6.89 against the Chinese yuan — a whisker away from 7, a level last witnessed in May 2008. The dollar has gained about 6 percent against the yuan since the start of the year, with much of the appreciation occurring in the last two months.

The Chinese currency has been weakening against the greenback due to both escalating trade tensions as well as rising interest rates in the U.S. driving up the value of the dollar.

China’s central bank sets a daily exchange rate for the yuan based on recent prices and allows trading against the dollar within a band of 2 percent above or below that level.

Recent weakness in the yuan has spurred some to say that China is allowing its currency to depreciate — either deliberately or in tandem with market forces — as the trade war with the U.S. hits its economy.

“China basically devalued in a retaliatory fashion to the tariffs that the U.S. imposed. I think that ended up being counterproductive,” said Brooks, who predicted both parties would try to find a way forward.

During his campaign for the White House, Donald Trump said he would name China a currency manipulator from his first day in office. But that rhetoric has been much more subdued during his presidency.

However, there are signs he is ratcheting up the heat again.

“In China, their currency is dropping like a rock and our currency is going up, and I have to tell you it puts us at a disadvantage,” Trump said in a CNBC interview last month.

But many currency experts say that a weak yuan would actually be bad for China as it imports most of its parts from the rest of Asia. So, any manufacturing components priced in a non-yuan currency become more expensive in local terms, raising the cost of producing Chinese goods.

There’s also Chinese debt denominated in the dollar, which would become more burdensome when the yuan weakens.

Analysts also said the yuan is not undervalued in the current global environment — it’s simply weakened alongside softening economic data from the world’s second-largest economy.

U.S. tariffs on $34 billion worth of Chinese goods came into effect last month.

Earlier this month, the Trump administration proposed raising tariffs to 25 percent on $200 billion worth of Chinese goods.

The upcoming trade talks will likely focus on how China can manage its currency to get some relief from the U.S. tariffs.

“A lot here is going to center on ‘China undid some of the impact of the initial round of tariffs, so you can appreciate the RMB and help us out,'” said Brooks. Otherwise, the U.S. could continue to threaten Beijing with higher tariffs, he added.

Under Secretary of Treasury for International Affairs David Malpass, who is leading the coming trade talks, will likely warn China against further depreciation of the yuan, said political risk consultancy Eurasia Group in a note on Friday.

But Beijing will stress “that China is not seeking to weaken the currency but allowing the exchange rate to respond to the pressures of the trade war, a slowing domestic economy, and monetary easing,” Eurasia analysts wrote.

“A potential risk is that the U.S. insists that China force the yuan to appreciate back to recent highs (the RMB has weakened by 9% since end-April, in part due to a broadly stronger US dollar). Beijing will likely dismiss such demands as unworkable in the face of market pressure,” the Eurasia report said.

Nonetheless, coming to a compromise of sorts during the talks will help China because a weakening yuan comes with its own set of problems.

“China is basically a country with a wealthy, well-to-do middle class; it has assets. As the RMB bilateral exchange rate goes towards 7, I think capital flight is going to become an issue,” said Brooks, referring to how investors will pull their money out of the country if the yuan becomes too weak.

In the second half of 2015, the Chinese government shocked markets by devaluing its currency. That spurred investors to move their money elsewhere due to concerns over the health of the Chinese economy, further depressing the yuan. Beijing has been trying to reverse that damage.