The trade war took a dangerous turn and is now morphing into what many are
calling a currency war.
It's all out economic warfare between the two biggest economies in the
world.
U.S. and China.
Two key developments took us here.
The Chinese currency weakened passed a significant level that investors
were thinking maybe China would defend—an indication perhaps that China
was stepping up its fight in the trade war.
The U.S.,
in response, designated China a currency manipulator, something that the
U.S. Treasury hasn't done since 1994.
And while mostly symbolic, was seen as a big aggressive move to call China
out and just escalate this trade tension even farther.
What makes it difficult is that when you have a currency war, everybody
wants a weaker currency.
Weaker currencies help your exports stay more competitive on a world
stage. But not everybody can have a weaker currency.
So in response to the U.S.
and China's moves on currencies, we saw other central banks and economies
take action like India, Thailand and New Zealand, all surprising their
markets through monetary policy and all weakening their currencies.
If everybody races to the bottom, it can be very disruptive to markets and
to the global economy.
When the Treasury formally calls out another country for being a currency
manipulator. Not much happens.
It's largely symbolic.
It's a badge of dishonor.
It's considered embarrassing and puts that other country at the top of the
G-20 agenda for discussing what it's doing with its currency.
In practice, not much explicitly happens.
The Treasury engages the International Monetary Fund and China in
negotiations and discussions about what the currency has actually been
doing and how they're going to fix it.
However, this administration doesn't necessarily play by the same rulebook.
So many are worried that by designating China officially a currency
manipulator, President Trump could use that politically and on the world
stage to just impose more tariffs, other sanctions and other economic
punishments. Now, that's not necessarily in the Treasury rulebook for how
this goes.
But we've seen President Trump break the rules.
Mostly everybody wants a weaker currency.
There are benefits to having your currency be weak.
Number one, it makes your exports more competitive.
If you're Japan and selling Hondas and Toyotas to Americans, it gives them
an edge over companies like GM and Ford.
It also makes earnings more competitive.
S&P 500 earnings have gotten hit this year because the dollar's been so
strong.
Anybody that does business overseas, from Apple to Procter and Gamble to
the automakers to John Deere, which President Trump also called out during
a tweet, their earnings and their revenues get cut by that strength of the
dollar. They sell overseas.
It's less competitive.
They bring the money back home.
It's worth less.
We've learned this lesson so many times.
And that is currency wars and tensions fueled by countries trying to
weaken their currencies can have a very destabilizing effect on growth and
on stock markets.
It happened in 2015.
China made a surprise decision to let its currency weak and devalue the
yuan. Guess what?
That led the S&P 500 into a correction, 10 percent off the highs.
That's why as soon as we saw China let its currency weakened, it sparked
all sorts of concerns, not just about the escalation of the trade fight,
but about what's really happening beneath the surface in China.
When countries devalue their currencies, it leads investors to wonder, is
their economy suffering worse than expected?
Are they going to have to deal with capital flight, a scary prospect where
people take money out of their economy.
We're not talking about in a small emerging market like Turkey, where we
had these concerns.
We're talking about China, one of the biggest markets in the world and the
second biggest economy in the world.
When you have other countries stepping in, then to fight to protect their
economies and their currencies, it's this notion of a race to the bottom
on interest rates and on currencies.
And that is what spooked markets.
The fact that it's going to be unpredictable, it's going to be a source of
tension and ultimately it's going to kill growth because tensions put up
walls between countries.
Trade slows down.
Tensions emerge.
And that's sort of been the theme of what we've been seeing on trade and
now currencies in 20 19.