China has denied it is devaluing the yuan to counter American tariffs

China has denied it is devaluing the yuan to counter American tariffs

Last week's decision by the US to formally label China a currency manipulator is likely to lead to a hardening in the trade dispute between the two countries, and slower expansion in both economies, experts have warned.

The announcement by the US Treasury Department on 5 August pushed the yuan to a fresh low against the dollar, falling below 7 per dollar for the first time since the global financial crisis in 2008.

While China has denied it is devaluing the yuan to counter American tariffs, the White House said it will respond forcefully if China weakens its currency to offset the effect of tariffs.

"We expect that the positions of both countries on the trade dispute will harden," say analysts at Moody's Investors Service.

They believe heightened tensions point to a risk that the US will further increase tariffs on Chinese imports and Beijing will make retaliatory responses. "This raises the prospect of slower economic expansion in 2020 than the 6.0% for China and 1.7% for the US that we currently forecast."

More broadly, worsening trade and currency tensions between the US and China will curb global growth, they say. And market expectations of further declines in the renminbi may also lead to devaluation in other currencies, particularly those with strong trading ties with China.

The escalation of trade tensions began at the beginning of August when US President Donald Trump announced that from 1 September an additional 10% tariff will be levied on all US remaining goods imported from China that have not yet been hit with punitive tariffs.

The September increase would impact core apparel and footwear products for the first time in the trade war, and increase cost pressures on US retailers and importers. 

For China, a weaker yuan will make the country's exports cheaper – at a time when new figures show unit prices on apparel products imported into the US from China have already fallen in the first half of this year, while those from its Asian competitors have risen.

And the CEO of German sportswear maker Adidas AG last week said he fears a currency war between the US and China more than the threat of increased tariffs – due to the potential slowdown in the global economy and the hit on earnings when translated back into euros.

Moody's has identified "three plausible paths" for US-China trade tensions: 

  • A scenario in which there is no trade deal, but also no further escalation in the dispute as trade talks continue well into 2020; 
  • A hardened stance scenario, in which trade tensions ratchet up, with both countries placing punitive tariffs on all of each other's imports and imposing other restrictive measures; or 
  • A significant softening scenario, which envisions a resolution of some differences that results in a trade deal and the lifting of at least some of the existing tariffs.

"The latest development makes the hardened stance scenario more likely to materialise," its analysts note. "Under this scenario, we expect that the impact on economic activity would be material, shaving an additional 0.3 percentage point from US growth and 0.5 percentage points from China's growth over a year through direct channels. 

"The magnitude of the total macro impact would be much larger than the direct effect of the measures imposed because of second-order effects on sentiment and the financial sector."

They also warn: "Spillovers on investment and through the global production chain would be much larger."