by Mish Shedlock, The Maven:
Setser discussed three alternatives, then thoroughly debunked option three.
- Imposing new limits on U.S. firms operating in China, and taking actions that limit their sales in China. Apple and GM sell a lot of made-in-China phones and cars that wouldn’t be impacted by tariffs.
- Weakening China’s currency to offset the drag on China’s economy from far reaching tariffs. A standard, empirically well-grounded, rule of thumb is that a 10% depreciation (against a basket) raises net exports by about 1.5 percentage points of GDP—which could effectively offset realistic estimates of the economic drag of a trade war on China. This option isn’t without risks—it could reignite now contained capital outflows from China, and China might ultimately end up with a bigger-than-initially desired depreciation.
- And the perennial threat that China would sell its Treasuries. That could happen as a byproduct of a decision by China to push its currency down—if China signals that it wants a weaker currency, the market would sell yuan for dollars, and controlling the pace of depreciation would require that China sell reserves. Or could happen even if China maintained its current basket peg and shifted its portfolio around—selling Treasury notes for bills, or selling Treasuries and buying (gulp) Bunds (if it can find them—it might end up buying French bonds instead) or JGBs.
“Treasuries sales in a sense are easy to counter, as the Fed is very comfortable buying and selling Treasuries for its own account. I have often said that the U.S. ultimately holds the high cards here: the Fed is the one actor in the world that can buy more than China can ever sell,” said Setser
I agree with Setser that option three poses few problems for the US while creating problems for China.
However, I also noted that China sold US dollar assets to shore up the yuan and stop capital flight. Parts of points two and three conflict.
Here are further explanatory Tweets from Setser.
Selling Treasuries to Limit Depreciation (Strengthen Currency)
yes, China sold US bonds (and equities) to limit CNY depreciation back in 15/16. Controlling a depreciation once you have created expectations that you want a weaker currency is hard
— Brad Setser (@Brad_Setser) 22 June 2018
