Back in 2011, in a rare display of bipartisan cooperation that split both Republicans and Democrats, the Senate passed a bill aimed at addressing China’s currency manipulation. The 63-35 vote found 16 Republicans joining Democrats to vote for the measure, and five Democrats joining 30 Republicans to vote against it. The bill's sponsors included individual senators from widely different philosophical backgrounds, including Sherrod Brown (D-Ohio) and Lindsey Graham (R-SC).
At the time, the Chinese warned the measure could kick off a trade war — and the bill died when House leader John Boehner, who originally called the measure "dangerous," did not bring the measure to a vote in the House.
The bill would have imposed tariffs on countries caught manipulating their currency, and today there is once again evidence that China is doing just that to protect their manufacturing sector. The People’s Bank of China cut the reference rate on the yuan by 0.01% to 6.1694 per dollar, lowering the country’s currency fix to the lowest level since September.
It’s starting to appear that we’re already engaged in trade war with China — but only one side is fighting.
The move comes after China’s industrial profits dropped from 10.7% in March to 9.6% in April. When exports start to sag, China weakens its currency to maintain their price advantage in manufacturing. While the details are complex, imagine a sporting event where one team was free to disregard the rules, and you get an idea of what it’s like trying to compete with Chinese manufacturing. China is not the only country playing the devaluation game to protect manufacturing, as Japan and Korea are also included among the usual suspects, but the Chinese are the reigning champions of the craft.
The biggest and most disturbing news, which has largely been overlooked in the financial media, is that China and Russia reached a $400 billion energy deal where the two countries exchange funds in their own currencies. In simple terms, the Chinese will be paying for natural gas in rubles and Russians will be paying for their purchases from China with the yuan. Doing so cuts out the US dollar, the reserve currency nations typically use to pay one another for commodity exchanges.
While the China/Russian energy deal is small potatoes in terms of the dollar volume, the implications are huge. If a country were kicking off a trade war to try and knock off the world’s reserve currency, this is exactly what the first shot would look like. It also helps explain the recent push by China to take a larger role in setting global gold prices, by opening up a gold exchange in the Shanghai Free Trade Zone. And that’s where things start to get really strange.
Last week, in an international economic conference in St. Petersburg, Russian president Vladimir Putin came out with a bizarre statement about China and Russia needing to secure both their currency and gold reserves. The obvious question a statement like that begs is, secure them against what? What exactly does Putin think is going to happen to their currency and gold reserves?
To really take a shot at becoming the world’s reserve currency, the Chinese still have a ways to go. They would have to set up a thriving and free bond market; and perhaps the gold market in the Shanghai Free Trade Zone, selling gold certificates denominated in the yuan, is simply the first brick in that wall. While the gold exchange itself could be dismissed as a reaction to the pricing fixing scandal in London, adding Russia to the mix makes the whole picture a lot more ominous.
Congress may have had the right idea for a change back in 2011. It’s now starting to appear that we’re already engaged in trade war — but only one side is fighting.