Donald Trump’s trade war is in full swing.
I’m not a fan.
But, taking an independent view, Trump is correct with his approach. He wants fair trade. The US has been ripped off. Lots of countries are charging tariffs on US products. That’s what’s driving Trump’s hard-line approach. He won’t stop until countries cut or eliminate their tariffs.
That would benefit trade and create jobs in the US.
Perhaps, with a little bit more pressure, the world could end up with a free trade agreement. It might not happen tomorrow. But, hopefully with some common sense, politicians could make the right decision.
However, let’s not hold our breath. We are dealing with politicians…
To make matters worse, Trump has accused China of devaluing their currency. He believes that has given them an unfair trade advantage. Trump wrote in a tweet on 16 April:
‘Russia and China are playing the Currency Devaluation game as the U.S. keeps raising interest rates. Not acceptable!’
Take a look for yourself:
Like we said: Trump believes that China is ‘manipulating’ its currency lower. But he is wrong.
The truth behind China’s currency ‘manipulation’
The People’s Bank of China pegs the yuan to the US dollar, allowing it to fluctuate within a 2% band. The goal is to promote a stable currency for business and investment purposes. China wants cheaper imports, via a stronger currency, to create cheaper goods.
Trump should know that’s smart business.
The West has been brainwashed by socialism. Minimum wages and benefits are the name of the game. It’s difficult to compete with a country that implements none of the above. China offers cheap labour. The combination of cheap inputs (imports) and labour equals cheaper Chinese goods.
So, while a cheaper currency can increase exports in theory, the stable currency has promoted more business investment. That’s supported economic growth, allowing China to become a powerhouse.
China wants a strong currency.
Remember, a lot of it’s iron ore, coal and steel producers are bankrupt and won’t admit it. The insolvent producers need cheaper imports to keep their costs low and pay back their debts. If the currency depreciates, it’s going to cost more to import coal and iron ore to make steel. That could put a lot of steel manufacturers out of business.
A weaker currency won’t promote business investment — it could destroy the country’s economy.
Indeed, Trump is totally wrong by calling China a currency manipulator. It’s clearly not pushing its currency lower. It’s undercutting the market with lower prices, in order to keep its economy from falling apart.
That requires a stronger currency.
The yuan is destined for new lows
But there’s a catch: the yuan peg — as explained above — will probably break. It’s costing trillions to prop up the currency. If the greenback gains more momentum, the cost of supporting the currency might blow out.
That would eat into reserves ― a total waste of money.
China knows how this works and isn’t supporting its currency (as much) lately. South China Morning Post reported yesterday:
‘The Chinese yuan dropped to 6.70 against the US dollar for the first time since August last year as traders bet that the central bank is trying to engineer a weaker yuan as a weapon in its trade conflict with the US.
‘Offshore yuan, which is traded by international investors, was changing hands at 6.7320 per dollar on Tuesday morning, down 0.7 per cent from the previous close. It last traded below 6.70 on August 8.
‘The offshore yuan has now dropped for 14 consecutive days and is down by a total of 5.4 per cent from June 13. The losing streak began the following day, when the People’s Bank of China opted not to follow the US’ lead in increasing the interest rate.’
I wouldn’t be surprised if the currency drops by 20–25%, when the yuan peg breaks. The Chinese government has supported the peg, which has overinflated the currency. But that could change, quickly.
South China Morning Post added yesterday:
‘“Analysts are widely speculating that the PBOC is willing to see a weaker yuan to prepare for the impact of the trade war,” said Jasper Lo, chief investment strategist at Hong Kong-based Eddid Securities and Futures.
‘“The yuan has gone down a total of 5 per cent in the past 14 trading days. The level of 6.70 per US dollar will be a resistance level. The PBOC would like to see a weaker yuan but does not want to repeat the mistake it made in August of 2015 when it fell more than 2 per cent in one day,” Lo said.’
Lo might be correct.
But what if he’s wrong?
I believe the free market will decide where the yuan will go in the future ― not the PBOC. If there’s enough pressure and the trade war gets worse, the yuan peg could break. That sounds crazy today. But imagine what President Trump would say if the yuan falls by 25%!
Get reading for the biggest yuan devaluation in history
If China’s currency drops by 20–25% in one swift move, there will be massive volatility across financial markets. It would probably trigger a massive stock market correction in the US. That would likely impact Australia, as a result.
Take a look at the Dow Jones Industrials Index:
Source: Incredible Charts, Twitter
The trade war is pushing US stocks to breaking point. There’s major technical support at the 24,100 zone. A weekly closing below that level suggests a drop to 23,350 points in the weeks ahead. Remember, when the US market sneezes, the rest of the world ― including Australia ― tends to catch a cold!
Remember, a major yuan devaluation could trigger multiple defaults in China. That’s because the country’s competitiveness would reduce, significantly. It would become more expensive for the country to import goods. That could kick-start another major stock market correction.
The bottom line: expect the unexpected!
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PS: Financial expert Vern Gowdie explores why a credit collapse could occur in 2018, and how you can protect your assets. Click here for free action plan.