US-China Trade Dispute Leads to Currency War

The U.S. Department of the Treasury labeled China a currency manipulator on Monday (local time). The department is claiming that the Chinese government controlling the foreign exchange market has forcefully appreciated the yuan to reduce its trade deficit. After the U.S. made an announcement to increase tariffs further, China responded with the depreciation of the yuan, driving down a dollar-yuan exchange rate to below 7.1 yuan to the dollar. Following the Chinese currency’s fall below 7 per dollar, Washington branded China a currency manipulator claiming that the depreciation of the yuan was intentional. The currency war is putting the global economy at the risk of even bigger chaos.

This was the first time in 25 years that the U.S. government named a foreign country a currency manipulator based on the Omnibus Trade and Competitiveness Act of 1988. Now, Washington will negotiate with Beijing for the appreciation of the yuan for the next year and may engage in indiscriminate economic retaliation against China if the two countries fail to make an agreement. Restrictions on U.S. companies’ investment in China, constraints on Chinese companies’ participation in the U.S. procurement market, and measures via the International Monetary Fund are expected for Washington to put pressure on Beijing to appreciate the yuan.

A currency war, unlike imposing import tariffs on specific items, affects currencies themselves, which are directly linked with the economic activities of the two countries concerned, including goods and services. Therefore, it has a far greater impact than tariffs. As the U.S.-China trade dispute, which began after the inauguration of the Trump administration, has escalated from a tariff war to a currency war, there is little possibility of successful negotiations. Rather, the recent development is a confirmation that trade protectionism is likely to be prolonged in the global economic landscape.

The conflict between the two largest economies in the world and stronger trade protectionism could mean a huge blow to the South Korean economy, which is heavily reliant on export. About 70 percent of the South Korean GDP comes from export and import – 38 percent and 31 percent, respectively, as of 2017. Compared to 20 percent for the U.S., 33 percent for China, and 30 percent for Japan, one can understand how big of an impact a shrinking global trade would have on the South Korean economy.

Stock markets in Asia have fallen for two days in a row in light of the news surrounding China’s currency manipulator status. The South Korean stock market plummeted once again on Tuesday below the 1,900 mark and the won-dollar exchange rate dropped to 1,220 won per dollar as the won’s value has decreased compared to the dollar, which is considered to be a risk-free asset.

It’s unlikely that the U.S. government will soon label South Korea a currency manipulator, but it should be noted that the exchange rate of the won has been swayed too much by the yuan. It is a natural result for South Korea with a large trade volume with China, but the U.S. may see it differently. The South Korean foreign exchange authorities also expressed on Wednesday a concern over an excessive impact of the yuan on the won. The authorities may need to make appropriate interruptions to separate the won’s exchange rate from the yuan. Future movements of the won must be closely monitored and market interruptions must be made if the exchange rate of the won shows intense fluctuations. The environment surrounding the South Korean economy is becoming harsher as time goes by.