One of the ways China can counteract Trump tariffs is by letting the yuan sink. Let's explore how much.

Bloomberg reports Hawkish Fed, Weak Yuan Signal More Trouble Ahead for Emerging Markets.

If you thought the first half of the year was rocky for emerging market economies, brace for turbulence ahead with dollar strength and a weaker Chinese currency set to keep investors on edge.

The yuan has slid six percent against the dollar since June and analysts say if further losses materialize, accompanied by rising Treasury yields and greenback, that will be a volatile mix. Investors will be tempted to pull capital out of emerging economies across the board; policy makers around the region will be forced to raise rates in response. Already, India’s central bank governor Urjit Patel has warned of the risk of a brewing currency war.

In a note dated Aug. 1, Deutsche Bank AG said it expects the yuan to trade at 6.95 and 7.40 against the dollar by the end of 2018 and 2019 respectively, compared with a previous forecast of 6.80 and 7.20. It was around 6.83 on Thursday afternoon in Hong Kong.

Currency Manipulation Setup

That does not address the question asked, but it explains the setup nicely. And if the Yuan weakens substantially, Trump would press "currency manipulation" charges.

One way China could avoid those charges is if it floated the yuan. I suspect it would collapse, but we are all guessing.

What Would it Take to Counteract Tariffs?

That question came up in a series of Tweets today.

The 5% fall in trade-weighted RMB may be enough to offset the 25% tariff on $50 bn Chinese imports and the 10% tariff on an additional $200 bn. But if that additional tariff is 25%, the RMB will have to weaken a lot further. That escalation would require $/CNY at 7.20 or above. pic.twitter.com/feRvCCRI80

— Robin Brooks (@RobinBrooksIIF) August 2, 2018

I asked: Robin, what is the math here. How do you figure? 7.20 is only another 4-5% away? Thanks Mish.

Chart From Robin

Mish. Think he is saying you need about double the total currency move to basically offset an approximate doubling of tariffs (rate applied to dollar amount of goods) .

— matchpenalty (@matchpenalty1) August 2, 2018

I understand what Robin is saying but I fail to understand the math. Regardless, let's assume it is true.

Look at the Deutsche Bank prediction of 7.40. That was for the end of 2019 but once again, everyone is guessing.

With that, let's review the three ways I mentioned that China could strike back.

Three Ways China Can Retaliate

1. Let the Yuan slide 25% negating the tariffs.
2. Further limit US firms ability to do deals in China
3. Halt Rare Earth Exports. Rare earths are 17 minerals used to make cell phones, hybrid cars, weapons, flat-screen TVs, magnets, mercury-vapor lights, and camera lenses.

Option one has capital flight risks for China of course. But US tariffs pose numerous risks to the US and global economy as well.

Option two is a given.

Option three is rarely discussed, but China has at least 80% of the global market.

For further discussion, especially of the Rare Earth angle, please see US Trade Policy: Not Only are We Stupid, We are Hypocrites

Winning Ain't Easy

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