What is a currency war and could Trump trigger one?

US President sparks new investor fears after criticising Federal Reserve interest rates as Chinese yuan plummets

Asian markets have tumbled following announcement of tariffs by US and China
(Image credit: NICOLAS ASFOURI/AFP/Getty Images)

As the US-China trade war continues to undermine global economic confidence, Donald Trump sparked new fears among investors last night by threatening a currency war with Beijing.

The Chinese yuan weakened by nearly 1% against the dollar yesterday and continued its slide today, hitting its lowest level in over a year.

“Analysts said the yuan's latest dip came after China's central bank indicated that it was willing to accept a weaker currency,” CNN reports, as it will help China's huge export industry cope with new US tariffs.

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Overnight, the US president launched a “rare attack on America’s central bankers”, The Guardian says, revealing that he “wasn’t happy with their plans to raise US interest rates”.

“Our currency is going up,” Trump said. “I have to tell you, it puts us at a disadvantage.”

What is a currency war?

Currency wars occur when a number of countries seek to depreciate the value of their own currencies in order to stimulate their economies, Investopedia writes.

Although devaluations are not unusual, most do not lead to currency wars - which begin only when several countries all try to push down the value of their currencies at once.

“Instead of making their exports better, they make them cheaper,” The Balance says. “Businesses can export more and the country benefits from stronger economic growth. But currency devaluation also makes imports more expensive. That hurts consumers and adds to inflation.”

The term was coined by Brazil's finance minister, Guido Mantega, who was describing a 2010 stand-off between the US and China.

What is China doing now?

The manipulation of the yuan, considered by many to be undervalued, is a direct response to Trump’s actions on global trade and protectionism, sparking fears that China could “turn a trade war into a currency war”, says Quartz.

The Chinese government has let the yuan weaken by around 4% against the dollar in the past month, among the sharpest one-month drops in value in its history.

That could help China's huge export industry cope with new US tariffs, as it makes Chinese products cheaper for buyers who pay in dollars. That could in turn boost an economy that posted its slowest growth rate in nearly two years - 6.7% - in the second quarter.

It will also make the American products China buys more expensive, reinforcing the effects of China’s tariffs on US-made goods.

However, it is a high-risk strategy. If the yuan falls too quickly, it could prompt money to flood out of China as investors lose confidence and seek to exchange it for assets in dollars and other currencies.

What is Trump’s response?

Chinese actions have prompted Trump to express dissatisfaction with the Fed’s monetary policy. That’s “pretty unusual”, says The Guardian, and “high risk” due to the Fed’s supposed independence from political influence.

However, his administration appears “determined to push down the value of the US dollar”, says Markets.com, in order to help US companies compete abroad, a key plank of Trump’s attempt to make trade “fairer”.

“I am not happy about it,” Trump said. “I don’t like all of this work that we’re putting into the economy and then I see rates going up.”

Nevertheless, reports CNN, analysts say China will be reluctant to weaken the yuan much further “as a weapon” in the trade war, pointing to the “chaos caused in Chinese and global markets by sharp falls in the currency in 2015 and 2016”.

In an interview with CNBC, Trump also threatened to impose tariffs on all of China’s $500bn exports to the US, a dramatic increase on the tariffs placed on $50bn of goods earlier this year.

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