I would like to look at the impacts of the tariffs war on the Chinese Yuan,

$USDCNY = onshore market

$USDCNH = offshore market

Let’s start with the background:

https://www.youtube.com/watch?v=RbM2F-cfN0A

More seriously, this is the timeline for the U.S. – China Trade War:

https://www.china-briefing.com/news/the-us-china-trade-war-a-timeline/

With a big start:

“May 3-7, 2018: US-China engage in trade talks in Beijing, where the US demands that China reduce the trade gap by US$200 billion within two years. Talks end with no resolution. “

From almost day one of the talks, the threat was on 200$bn.

First what about the trade deficit between China and the U.S.?

Deficit getting bigger and bigger…

It stands at roughly 400 $bn in 2018.

A 200$bn reduction means to go back to levels we had 15 years ago. That is a long shot from here.

As China is running a huge surplus with the U.S., they are not in the best possible position to negotiate.

Moreover, exports to the U.S. still represent a big chunk to the overall chinese exports:

with:

So with 20% of GDP coming from exports (not net exports or X of GDP) and 20% of those exports going to the U.S., you end up with 4% of the Chinese GDP in play.

With a rate of GDP growth declining for the last 10 years, it is normal that tariffs are taking the headlines these days.

Going through the tariffs’ timeline, I ended up with 4 important dates:

15/06/2018

“The United States will impose a 25 percent tariff on $50 billion of goods imported from China containing industrially significant technology, including those related to the “Made in China 2025” program.  The final list of covered imports will be announced by June 15, 2018. “

with China retaliating:

China revises its initial tariff list (25 percent on 106 products) to now include a 25 percent tariff on 545 products (valued at US$34 billion). This tariff will take effect July 6, 2018. China also proposes a second round of 25 percent tariffs on a further 114 products (valued at US$16 billion).

And guess what, this is when the yuan really started to weaken vs the US Dollar.

It broke a technical level and went almost straight in 3 months from 6.40 to 6.95.

Then on the 23/08/2018, a second round of tariffs was implemented for 16bn and finally on the 24th of September we had the 3rd round with another 200$bn making 250 bn at 10%.

At that time, we had roughly 250$bn of Chinese goods that experienced a 10% increase

vs

60bn of U.S. goods with 10% increase

That is to say 190$bn “against” China.

Let’s now assume that based on its massive surplus, China only weapon to balance the increased in tariffs was/is currency.

As we just highlighted, from January to September 2018, the war on tariffs generated roughly a balance of 190$bn Chinese goods taxed with a new 10%. In other words, that represents a 19$bn “new cost” for China.

Looking at the ~400$bn surplus between China and the U.S. and this 19$bn “cost”, best way for China to mitigate the effects was to weaken its currency by:

19/400 = 4.5%

– If you take the June 2018 USDCNH level (from round 1) and you apply a weakening of 4.5%, that gives you 6.70.

6.70 was the recent consolidation level we had before the new round.

– If you take end of 2017 level when there was no real talk on tariffs, you end up with:

6.6 * 1.045 = 6.90 or ~ top of the range in 2018

So based on the 3rd round of tariffs on possible slow devaluation of the yuan to balance them, where could the yuan be heading from here?

If you apply the same strategy (and you do not even take into consideration of the big Chinese economic slowdown since September 2018) on tariffs and USDCNH, you end up with:

U.S. increases tariffs on 200b worth of Chinese goods from 10 to 25%

or 200 x 0.15 = 30bn

With a ~400 bn surplus, to mitigate the tariffs increase, China needs to weaken the yuan by:

30bn / 400bn = 7.5%

That gives you either:

– 6.7 * 1.075 = 7.2 based on recent yuan level before imposition of new tariffs

or

– 6.95 * 1.075 = 7.47 looking at the recent top of the range

Obviously, this analysis is far from being perfect (as always) but a move towards 7.20/7.50 on USDCNH would not be that surprising.

6.95/7.00 is a big level to watch and a break would have big consequences across asset classes.

Again we only considered tariffs impact vs surplus and how for China to balance their effects. This is not even taking into consideration China GDP growth trend and/or the new economic plan decided by the Politburo in October 2018 and/or…

I hope it helps,
Gregoire

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