The Butterfly effect: The Renminbi

The trade war between China and the United States continues. The Chinese company Huawei and its subsidiary Honor were banned by the American president Donald Trump, unable to sell their products or work with American companies, closing a market of about 300 million Americans. We have to remember that Huawei is one of the largest Chinese company with almost 200,000 employees worldwide, and has gained ten percentage points in market share worldwide in this decade, reaching almost 14% of the world share of smartphones.

Recently, Donald Trump has raised new tariffs on Chinese products worth $300 billion. Xi Jinping’s response has not been long in coming, and it has been devalue the Chinese currency, the Renminbi.

This trade war began early last year when the Trump administration announced sanctions against Chinese products worth $50 billion. It is no accident, that shortly thereafter the Chinese president answered devaluing his currency (The Renminbi) from 6.3 CNY to approximately 6.9 CNY; The same happened with the sanctions in May of this year and, now China, is protecting itself against the new sanctions of  $300 billion that was established on September 1st, devaluing its currency above 7CNY:



The tariffs established by Trump make US imports from China more expensive, on the American border, so the devaluation of the Renminbi makes these imports cheaper, offsetting the tariffs imposed by the White House. This measure has been considered, by Donald Trump, as unfair and has described the Chinese president, Xi Jinping, as a “currency handler.”

But these tariffs, to protect local industry or to reduce foreign competition, is not new. The United States has established tariffs on European Union products such as footwear, transport vehicles or meat products. Since 2000, China bans the European Union from exporting beef products due to Bovine Spongiform Encephalopathy disease that took place in Europe in the ’90s. China uses restrictive trade measures, such as export duties, in a broad range of raw materials; Since 2000, China has applied production limits or export quotas to regulate the supply of Rare Earths, minerals necessary to make satellites, computers, mobiles, batteries … and China supplies 90% of world demand. In 2015, China removed some elements from this quota system, but export duties remain in force despite the requirements of the World Trade Organization.

This mercantilism carried out by Trump is not something unusual or new in the world, and the answer of the Chinese president has been to devalue his currency at an exchange rate not seen in the last 10 years. The benefits of free trade are obvious,  just check the Economic Freedom Index of countries such as Switzerland, Australia or Canada with the more closed economies such as North Korea, Equatorial Guinea or Bolivia.

This volatility of the Renminbi makes investors seek refuge in other safer assets such as gold or the dollar, investors run away from volatile or unstable markets and this has been seen in the stock market crash after the announcement of the Chinese president: the US stock market fell, the S&P500 fell 2.8%,  Nasdaq 3.7% and the Dow Jones 3.1%, the Hong Kong stock exchange -Hang Seng- fell 1.91%,  Tencent shares fell about 2.45%,  HSBC bank lost 1.58% … in just one single day. After the announcement of the Chinese president, the equity markets lost, approximately, 12.4 billion dollars, which represents the twelfth largest stampede worldwide, in history, in the stock exchanges in a single day. The consequences have not only been in the United States and Asia, but have also been seen in Europe: the Spanish stock market, Ibex 35, lost 1.35%, London 2.47% and, the French CAC and the German DAX lost 2.19 % and 1.80% respectively.

But not only the stock exchanges have suffered, with the devaluation of the Chinese currency, their exports are cheaper, but their imports become more expensive, therefore, the imports of natural resources (denominated in dollars) from Latin America become more expensive, causing a decrease of the demand and changing prices, which forces these countries to devalue their currency to counteract the effects of the fall of the Renminbi and, thus, stimulate exports to the Asian country. This devaluation generates inflation and loss of purchasing power, and causes more problems to highly indebted countries in dollars, such as Argentina.

A trade war between the two largest countries in the world: the US and China, but with global consequences. As a Chinese proverb says, “The fluttering of the wings of a butterfly can be felt on the other side of the world”, but in this case “A small devaluation of the Renminbi can shake the world”.

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