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Investors fear China may "weaponize" its currency in trade fight with U.S.

Ex-Trump aide: China tariffs hurting U.S.
China trade war backfiring on U.S., says former Trump adviser Gary Cohn 03:59
  • China allowed the value of its currency to fall below seven yuan against the U.S. dollar for the first time since 2008, raising investor concerns about an escalation in the countries' ongoing trade war.
  • President Donald Trump on Monday suggest in a tweet that China is engaging in currency manipulation and urged the Federal Reserve to respond.
  • Wall Street analysts said China may be starting a currency war with the U.S after Mr. Trump last week threatened to impose a 10% tariff on $300 billion in Chinese goods. 

Beijing — China allowed its yuan to fall below the politically sensitive level of seven to the U.S. dollar on Monday for the first time in 11 years, prompting concern Beijing might use devaluation as a weapon in a tariff war with Washington amid fading hopes for a trade deal. 

The central bank blamed the exchange rate's decline on "trade protectionism." That followed President Donald Trump's threat last week of more tariff hikes on Chinese goods in a bruising fight over Beijing's trade surplus and technology policies.

Mr. Trump early Monday rebuked China for letting its currency sink, suggesting that the country is manipulating the value of its currency.  

U.S. financial markets fell sharply on Monday amid the signs of deteriorating relations between the U.S. and China. In early trade, the Dow tumbled more than 500 points, or 1.8%, while the S&P 500 fell 1.8%. The Nasdaq index, which lists many technology companies that do business in China, saw an even bigger drop -- as of 10:02 a.m. Eastern time it was down more than 200 points, or 2.5%, to 7,799 points. 

"The fact that they have now stopped defending 7 against the dollar suggests that they have all but abandoned hopes for a trade deal with the U.S.," Julian Evans-Pritchard, senior China economist with Capital Economics," told clients in a report. 

The currency weakened to 7.0391 to the dollar by late afternoon, making one yuan worth 14.2 cents, its lowest level since February 2008.

"The thought of a currency war is crossing more than a few traders' minds," Stephen Innes of VM Markets said in a report.

The weakness of the yuan, also known as the renminbi, or "people's money," is among U.S. grievances against Beijing. American officials complain it makes Chinese export prices unfairly low, hurting foreign competitors and swelling Beijing's trade surplus.

"Further weakening of the [yuan] means that, globally, the pressure for the U.S. dollar to strengthen is rising," Louis Kuijs of Oxford Economics said in a research note. "Such dollar strength will be unwelcome in Washington, D.C., where President Trump has openly complained about a strong dollar and has threatened to try to weaken the U.S. currency."

Part of China's arsenal

China's central bank sets the exchange rate each morning and allows the yuan to fluctuate by 2% against the dollar during the day. The central bank can buy or sell currency — or order commercial banks to do so — to dampen price movements.

It appears "the currency is now also considered part of the arsenal to be drawn upon," Robert Carnell of ING said in a report. He said Monday's move might be part of "a concerted series of steps aimed at pushing back at the latest U.S. tariffs."

The level of seven yuan to the dollar has no economic significance, but could revive U.S. attention to the exchange rate. Until now, economists said the potential jolt to financial markets of falling beyond that level was big enough that the People's Bank of China would step in to put a floor under the currency.

Trump threatens new 10% tariffs on China 02:15

A central bank statement Monday blamed "unilateralism and trade protectionism measures," a reference to Trump's tariff hikes. But it tried to play down the significance of "breaking seven."

"It is normal to rise and fall," the statement said. It promised to "maintain stable operation of the foreign exchange market."

Chinese leaders have promised to avoid "competitive devaluation" to boost exports by making them less expensive abroad — a pledge the central bank governor, Yi Gang, affirmed in March. But regulators are trying to make the state-controlled exchange rate more responsive to market forces, which are pushing the yuan lower.

Limits on how far China can go?

Trump's tariff hikes have put downward pressure on the yuan by fueling fears economic growth might weaken. The U.S. Treasury Department declined in May to label China a currency manipulator but said it was closely watching Beijing.

The yuan has lost 5% since hitting a high in February of 6.6862 to the dollar. That helps exporters cope with tariffs of up to 25% imposed by Trump on billions of dollars of Chinese goods. But it raises the risk of inflaming American complaints.

Trump rattled financial markets Thursday by announcing plans for 10% tariffs on an additional $300 billion of Chinese goods, effective Sept. 1. That would extend penalty duties to almost all U.S. imports from China.

Trump threatens more China tariffs and attacks Democrats at Ohio rally 02:56

The Treasury report in May urged Beijing to take steps "to avoid a persistently weak currency." A weaker yuan also might disrupt Chinese efforts to shore up cooling economic growth. It would raise borrowing costs by encouraging an outflow of capital from the world's second-largest economy.

"Despite this breach of the 7 mark, we still don't expect Chinese policymakers to be comfortable with major weakening of the yuan," Kuijs said. "The concerns about triggering large financial capital outflows remain. Indeed, there are obvious tactical and time-specific considerations behind today's move."

A weaker dollar "would be bad news" for Europe and Japan, hurting demand for their exports at a time of cooling economic growth, he added.

The Chinese central bank tried to discourage speculation last August by imposing a requirement that traders post deposits for contracts to buy or sell yuan. That allows trading to continue but raises the cost.

Beijing imposed similar controls in October 2015 after a change in the exchange rate mechanism prompted markets to bet the yuan would fall. The currency temporarily steadied but fell the following year.

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