The China-US trade conflict is taking a more severe turn. President Trump announced a 10 percent tariff on an additional $300 billion of Chinese imports; the Chinese government responded by allowing its currency, the yuan, to fall to more than 7 to the dollar—the lowest in a decade; the US government then formally labeled China a “currency manipulator,” which carries no formal penalty but sets in motion a process that might lead to sanctions by the International Monetary Fund.
Zachary Karabell is a WIRED contributor and president of River Twice Research.
Currency moves are arcane. Only a few professional traders dabble here, though in East Asia, many people trade currencies the way people trade stocks in the US. Headlines blaring that “China devalues its currency” are as likely to be greeted with puzzlement as with outrage, and the fact that stock markets went into a tailspin only compounds the confusion. Trump tweeting accusations that China has been robbing America using its exchange rates are then filtered by partisans on both sides as proof that China is up to no good or that Trump has no idea what he’s talking about.
Exchange rates, though, do matter, and in the context of the escalating tariff war, the recent moves between the dollar and the Chinese yuan (also called the renminbi) matter greatly. Leave aside for the moment whether these oscillations are the result of Chinese government policy or market forces. Exchange rates matter because they determine the terms of trade: How many dollars a US consumer has to give up to get an item that’s made in China. In the current context, exchange rates can either intensify the pain of tariffs or relieve them. When the yuan loses value, it makes Trump’s tariffs less effective, which may be why he became so agitated.
Though Trump routinely claims that “China is paying for the tariffs,” that’s simply not true. Tariffs are assessed when an imported good enters the country imposing them, paid by the importer, be that a carmaker, a clothes retailer, or Apple. To date, the Trump administration has placed 25 percent tariffs on about $250 billion of Chinese imports. That means a company importing $1 million of goods from China pays an additional $250,000 to US Customs, making the total cost $1.25 million. The Chinese exporter still gets the same $1 million.
The logic of tariffs is that the higher price makes it less attractive to import from China. To date, the tariffs have affected mostly industrial goods, and not direct consumer products such as shoes, furniture or iPhones. But Trump’s latest proposal, which would go into effect Sept. 1, would cover all of those goods. When it arrives in the US, the iPhone XS costs Apple about $450; if the tariffs go into effect, Apple would have to pay an additional $45 to the US government. It could raise prices, seek to cut costs, or accept less profit. The same formula applies to all imports from China—Nike sneakers, KitchenAid appliances, home routers.
At least in theory. That is where these moves in exchange rates shift the calculation. The formula above leaves out the exchange rate. Exchange rates always fluctuate, but big moves in the value of a currency have major consequences. The recent decline in the value of the yuan largely nullifies the threatened tariff. Here’s the basic math: If a US importer buys $100 worth of goods from China when the exchange rate is 6.3 yuan to the dollar, that’s 630 yuan. If the exchange rate changes to 7, as it just did, then the US importer only needs $90 for the same purchase. If that import is then subject to a 10 percent tariff, the two cancel each other out and the cost to the importer remains basically the same.
The recent fall in the value of the yuan was interpreted by Washington as a deliberate move by Beijing to nullify the threatened new tariffs. The Chinese government has a history of intervening to manage the exchange rate. Some experts doubt whether Beijing did anything in particular and see the moves as global currency markets adjusting rates to compensate for the tariff threat. While the actual moves weren’t as steep as the hypothetical above (the rate went from 6.7 yuan to the dollar a few months ago to 7.1 this week), the effects are clear: If exchange rates move enough, the tariffs become largely symbolic, acting as a tax on American importers but not inflicting enough harm to force American companies to move production out of China, or to prompt the Chinese government to meet US demands.
It’s important to recognize that after more than a year of tariffs, US-China trade has plateaued but not cratered. The supply chains that took more than a decade to create, at a cost of hundreds of billions of dollars, cannot be so quickly unraveled or rebuilt. A weaker yuan will be additional ballast to the way things were before the tariffs. Companies will continue to talk about moving supply chains to Vietnam, Mexico, Egypt, Indonesia; some of that is happening and more will. But China remains a unique high- and middle-tech hub, especially for assembling the many components of computers, smartphones, and other electronics that are not as easy to move elsewhere as shoes or clothing.
The trade war is destabilizing financial markets and affecting hundreds of public companies, especially in tech, and thousands of smaller private ones. Tariffs on all Chinese imports, especially on the goods yet to be affected, will be a tax on American consumers. But currency moves are a wild card that few have focused on, which have the power to nullify the economic consequences of Trump’s tariffs and intensify the political conflict. It’s understandable that markets are gyrating, but the silver lining here might be that it will be harder to disrupt the symbiosis between China and the United States that has real problems but has also manifestly benefitted American companies and consumers.