Streetwise Professor

August 6, 2019

Do What I Say or I’ll Blow the Yuan’s Brains All Over This Town: Not a Credible Threat

Filed under: China,Economics,Politics — cpirrong @ 6:14 pm

The recent market tumult was precipitated by Trump’s announcement of new tariffs on China. But the effect of Trump’s action on the markets paled in comparison to the response to China’s retort: allowing the yuan to breach 7/USD. Today the market recovered some, because the yuan appreciated.

A couple of points. First of all, the yuan’s do-si-do demonstrates that it is a managed/controlled currency. Whether you call it a manipulated currency is a matter of semantics. It is not primarily moving in response to market forces, but instead to the dictates of the (laughably mis-named) People’s Bank of China, and hence to the whims of the CCP and Xi.

Second, and more importantly, although the move past 7 was clearly a threat by China to wage a currency war in response to Trump’s tariff gambits (and the market took it as such), this threat is not credible. It reminds me of this classic, but no doubt politically incorrect, scene from Blazing Saddles: “Drop it, or I’ll blow the yuan’s brains all over this town.”*

The threat is not credible, because like Cleavon Little’s cranium in Blazing Saddles, China would be hurt most if it carried through on the threat. Yes, a depreciating yuan would favor Chinese exports and offset (for a while, anyways) the effect of tariffs. But a weak yuan would wreak havoc on many Chinese firms that have borrowed in dollars. Given the dodgy state of the Chinese banking system, this could readily metastasize into a full-blown financial and/or currency crisis. It would also spark inflation and totally undermine the stated (but largely unrealized) goal of moving China towards a consumer-driven economy.

There are no doubt many (perhaps even a majority) in the US (and the West generally) who will be as stupid as the townspeople of Rock Ridge. I doubt Trump is one of them. Or if he is, I doubt he would lay down his guns: he’d be happy to see Xi pull the trigger. So I expect him to call the bluff.

One last thing. Framing the US-Chinese relationship in terms of “trade war” is stupidity befitting Governor Le Petomane. Trade is just one front in a far broader great power contest between a revisionist power and the status quo power. After decades of complacency, interrupted by spasms of romanticism, the US recognizes China as its primary strategic competitor and threat. The contest is being joined on many fronts, analogous to the Cold War. The main distinctions are that China is not nearly the same nuclear threat that the USSR was back in the day, but China is far more formidable economically than the USSR ever was. Hence there is an economic dimension to this competition that was largely lacking 1945-1991.

Trade is not the war. Trade is a weapon in a larger war.

*In fact, most of Blazing Saddles is beyond the pale today. There is no way it could be made in 2019. This is a sad testament on the utter inability of our alleged elite to see past the superficialities in order to grasp the true message of Brooks’ classic film. As a result, IDGAF if anyone gets the vapors over my reference to the most politically incorrect scene in a very politically incorrect–but brilliant–movie.

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  1. Oddly enough, viewing China as a strategic competitor seems to be the one area where Democrats and Republicans are somewhat in agreement (bar some occasional sniping and pot shots). I daresay Democrats are holding their tongues and waiting to see what results Trump’s tariffs will produce.

    China has been rather clumsy in trying to exploit divisions by targeting America’s farmers: the one sector that is pretty rock solid behind Trump. It bespeaks of a cultural myopia; you’d think that they’d have better advisors, given the access they have to America.

    Their retaliations would probably be more effective should they deny some key components that would drive up the price of Gameboys and other electronic toys that millennials crave. They certainly have the stranglehold on rare metals to do it.

    Comment by I.M. Pembroke — August 6, 2019 @ 10:33 pm

  2. It seems like the whole US establishment lets Trump play the Bad Cop.

    Comment by tegla — August 7, 2019 @ 1:01 am

  3. That is one of my favourite films, as it is for my wife too. Mel Brooks was on top form there.

    Comment by Tractor Gent — August 7, 2019 @ 4:36 am

  4. The initial dip may have been dictated, but further weakness will not only damage Chinese firms who have borrowed dollars, but trigger even more capital flight. What had always amazed me is the confusion of our experts on increasing exports from China as a response to trade threats. Has it occurred to anyone that this might be another form of capital flight, moving assets out of reach of domestic creditors and bypassing currency controls?

    Comment by sotos — August 7, 2019 @ 12:24 pm

  5. China has not sold US Treasuries either, that would hurt China more too.

    Comment by Tom — August 7, 2019 @ 7:30 pm

  6. Interesting links in this post re the Chinese economy

    Comment by Sotosy1 — August 21, 2019 @ 2:50 pm

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