China Challenges King Dollar

China Challenges King Dollar

How does the US solve a problem like China?

More to the point, how does China solve a problem like the US?

Tensions between the two biggest economies in the world are high.

President Trump appears keen to ‘tariff’ China into submission.

Chinese authorities, on the other hand, have taken a reactive approach to Trump’s attacks.

Meanwhile, the media fixates on the misguided idea that Trump has the upper hand in the tit-for-tat trade war. That’s due to the trade imbalance that exists between the two trading partners.

The US buys a massive $631 billion from China. That’s three times the $155 billion of goods China imports from the US.

But what if Trump and the media at large has vastly underestimated what China can do to retaliate?

No, China may not be able to ‘out-tax’ the US. But the Middle Kingdom can take seemingly small actions that could have catastrophic consequences for the US dollar.

The ‘unofficial’ trade war became somewhat more official a fortnight ago when Trump’s $45 billion in proposed tariffs on specific goods went into effect.

Within hours, China made good on its promise to fire back, implementing $45 billion in retaliatory tariffs.

But there could be more to come.

Bloomberg reports that Trump is reloading his ‘tariff war bazooka’ and has another $291 billion in duties lined up.

While President Trump has denied that the spat is a trade war — claiming it a matter of national security — the application of one tariff followed by a retaliatory tariff is in fact the technical definition of a trade war.

With another $291 billion in tariffs on the cards, China doesn’t have as much room to continue with retaliatory tariffs.

Or does it?

Sinking a currency to win a trade war

Early in Trump’s election campaign, he was keen to label China a currency manipulator.

And he’s not wrong.

The yuan’s value is fixed to the US dollar. But China’s central bank, the People’s Bank of China (PBoC), ‘allows’ the yuan to rise or fall 2% from the previous trading day’s closing price. If the yuan looks like moving more than that in either direction, the PBoC has the power to step in and halt trading.

That’s currency manipulation, irrespective of how Chinese authorities choose to dress it up.

In August 2015, the PBoC reset the yuan to start the trading day 1.9% lower than the day before. This was the biggest one-day yuan ‘reset’ in memory. That one instance of interference caused global markets to tumble for the rest of that month.

The next yuan devaluation came in January 2016. That was when Chinese authorities ‘abandoned’ the 2% fall circuit breaker.

In other words, when the yuan’s value fell during trade by 2% or more to the US dollar, the PBoC didn’t step in to fix things.

Given that China can’t out-tariff the US, allowing the yuan to weaken against the US dollar should be expected.

In the past five weeks the yuan has fallen 3.3% against the US dollar. It’s down a total of 5.4% stretching back to April.

Yet throwing more taxes and duties at China won’t really change things as Trump seems to believe.

Take Apple, for example. Of the 46 million iPhones that were sold worldwide last year, more than 22 million of them were snapped up by US consumers.

Where were those iPhones made? China, of course.

So Apple is in no hurry to relocate its factories out of China.

In fact, most electronic goods US consumers buy are made in China. Same with clothing, footwear, toys and a whole host of other goods.

So Trump’s tariffs will only hurt the US consumer in the long run. The very consumer Trump reckons he’s helping. And that he said would benefit from massive corporate tax cuts.

In theory, if companies paid less tax, they’d be able to hire more workers and then people would have more money to buy more things from China.

As you can see, Trump’s policies are working at loggerheads with one another.

China challenges ‘King Dollar’

There’s an additional problem that Trump hasn’t accounted for.

And that’s reducing the number of US dollars circulating in the financial system.

The so-called ‘King Dollar’ is the lynchpin of the global financial system. Not least because its other moniker — the petrodollar — ensures that everyone needs US dollar reserves to buy oil.

Now, the US desperately needs the rest of the world to continue using US dollars so it can keep running massive budget deficits by expanding credit without ever having to worry about paying back that debt.

And it’s a big debt.

The US currently sits on top of US$21 trillion in debt. That pile grows at about $500 billion every six months.

Not only that, Trump’s recently implemented large corporate tax cuts are likely to reduce the amount of income the US government receives until — if at all — economic activity picks up.

In the meantime, the US has no intention of slowing spending.

It continues to issue US Treasury bills as a way to finance its debt.

Now, importantly, three quarters of US debt is sold to the American public. However, a fair chunk of this is bought by other countries. China, for one, holds US$1.18 trillion of US Treasury bonds.

I wonder if Trump knows he’s paying China interest for buying US debt?

Regardless, the US can only keep its economy ticking over if there are buyers for US Treasuries.

But with Trump targeting China through his trade war, there’s little incentive for China to keep buying US debt.

What happens if China suddenly stops buying US debt?

With no new buyers, the US can’t go on spending like it has. And if the federal government can’t spend as much as it does now, we are looking at the prospect of the biggest economy in the world falling to its knees.

The de-dollarisation begins

If China really wants to hit the US where it hurts, it could target US oil exports.

China plans on introducing a 25% tariff on US crude imports. That’d be a big move, as 20% of all crude exports from the US go to China at present.

On top of that, there are suggestions that China will increase crude oil imports from Iran.

Doing so would also be a direct shot at the US by blatantly ignoring its sanctions on Iran.

However, Iran won’t be able to meet all of China’s oil needs. But China can make friends with nations the US is hostile towards. Russia and Venezuela are other possible contenders.

The bonus in dealing with countries the US has sanctions against means that all parties can trade without US dollars.

With just a couple of moves, China could potentially usher in the final phase of long-talked-about de-dollarisation of the global monetary system.

Strap in — the rollercoaster is just beginning to pick up steam.

Kind regards,

Shae Russell Signature

Shae Russell,
Editor, The Daily Reckoning Australia