The Australian dollar hit a 10-year low on Tuesday after getting caught in the crossfire of the escalating trade war between the US and China.
With US President Donald Trump poised to introduce further 10 per cent tariffs on $US300 billion worth of Chinese imports from September, the People’s Bank Of China (PBOC – China’s equivalent of the Reserve Bank) took the unexpected decision to devalue the local currency below 7 yuan to $US1.
The move should help offset the impact of the US tariffs, but struck markets hard, with Wall Street having its worst day of 2019, and Australia’s leading ASX 200 share index following suit, falling 2.9 per cent in the first 10 minutes of trading on Tuesday, and closing down 1.88 per cent.
Why the Australian dollar took a hit
After China’s currency devaluation, the Australian dollar fell to a decade-low price of $US0.675, and Justin Rampono – director of foreign exchange comparison site Currency Shop – said that was no coincidence.
“The Australian dollar is really caught in the crossfire of this trade war,” he said.
Currently, the Australian dollar is being supported by high commodity prices (a boon for the nation’s resources industry), but is facing pressure from low interest rates (which make the currency less attractive to foreign exchange markets).
Over the past six months, Mr Rampono said falling interest rates and expectations that more cuts are on the cards have steadily forced down the dollar.
China’s currency devaluation adds further downward pressure by making it more expensive for China to import goods while taking a swipe at the US economy.
“I don’t think [the Australian dollar] is going to go down to 50 cents, or even below 60, but there’s certainly still a bit of downward pressure on it, particularly if you see commodity prices ease off. Over the last 12 months one of the things that’s been propping up the dollar, and stopping it from dropping further, is that we’ve had really strong commodity prices.”
Cheaper yuan ‘neutralises’ tariffs
China’s currency is unlike most other OECD nations’ in that its value is directly pegged to the US dollar, rather than ‘floating’ on the open market.
This means that unlike the US and Australian dollars – whose values are decided by supply and demand – the Chinese government is able to simply choose the value they think their currency should trade at, Mr Rampono said.
In this case, the PBOC looks to be using that power to partially offset the impact of the tariffs by making affected goods slightly cheaper for US importers.
The move was enough for President Trump and the US Treasury to label China as a ‘currency manipulator’ – suggesting the country is influencing exchange rates to gain a competitive advantage.
Treasury vowed to take its case to the International Monetary Fund in retaliation.
University of Technology Sydney’s Australia-China Relations Institute deputy director James Laurenceson, however, said the devaluation was more likely driven by external market forces.
“The US has said China won’t let the market decide these things, and then when China doesn’t intervene and does let the market decide, the US goes and accuses China of being a currency manipulator,” he said.
“What this shows is the utter economic illiteracy of the current US administration.”
Instead, the decision to let the yuan fall so low most likely suggests that China no longer feels it will be able to placate President Trump and is instead simply responding to supply and demand from global markets.
UBS economist Tao Wang similarly noted that of the US Treasury’s three ‘currency manipulator’ qualifications, China has met only one.
Dr Wang also noted that China has used “a number of measures” over the past year to keep its currency valued above 7 yuan to the US dollar in response to pressure from the US, though it “has not directly intervened” in foreign exchange markets to do so.
“In our view, the latest US move, together with the unexpected US tariff hike on Chinese exports on August 1, could be seen as further evidence that the US administration may not really want to reach a trade deal soon and reduce China’s incentive to make additional concessions,” Dr Wang said.
“We think China suspending new purchases of US agricultural products and letting [its currency break the 7 yuan per US dollar barrier] yesterday are perhaps reflective of that.
“It remains to be seen how China will react to the latest US move, but we believe there is an increasing risk to a delay or cancellation of the planned trade talks in September.”