DUMUNA

The US and China: Conflict Over Currency

Written by: Md. Injam Uddin
(General Member, DUMUNA)

Since 2018, we are perceiving an unprecedented hot talk between the world’s two largest economies- the United States and China. During the 2016 presidential campaign, Trump laid out a plan to counter China’s unfair trade practices by applying tariffs on Chinese goods. In July 2018, the US imposed tariffs on all imported washing machines and solar panels including those imported from China. China responded similarly by imposing tariffs on US products. These continuous tariffs caused the slow GDP growth of China. For stabilizing its economic growth, China devalued its currency and was labeled as ‘Currency Manipulators’ by the US government. On the other hand, in 2019, it came under the light that China is preparing itself for the digital currency era developing and using its own digital currency ‘e-RMB’ and China, Russia and Pakistan formed an alliance to reduce dependency on dollars and increase their currency’s value. The trade war gradually turned into a currency war. But why does Trump impose tariffs in the first place? Why did China respond to the trade war devaluing its currency? Why is e-RMB a matter of concern to the world? And most importantly how Bangladesh is being affected by the war? These all have been discussed in the writing. But before we jump onto our topic, we need to know what currency war is and how it occurs.

What is the Currency War?

A currency war occurs when a country devalues its domestic currency to gain a competitive advantage in the market and to stimulate its economy at the expense of others. Generally, currency depreciation is a common phenomenon in the global exchange market. And most importantly the currency exchange rate is determined by market forces in today’s floating exchange rate system. But in the currency devaluation process, a country’s central bank determines the country’s exchange rate. A country devalues its domestic currency to gain a competitive advantage in the market by balancing trade (total export minus total import). Let’s understand the devaluation process and its advantage through an example. 

The US and Bangladesh have an exchange rate of $1.00 = BDT 85.00 (approx.). The US imports mangos from Bangladesh which costs $1.00 per kg. That means the same 1 kg mango costs 85.00 takas in Bangladesh. After a few days, Bangladesh Bank determined the exchange rate of $1.00 = BDT 170.00 (approx.) devaluing its value. That means consumers of the US will get one more kg at the same rate. It may seem that Bangladesh is incurring loss devaluing its currency and offering one more kg of goods at the same rate. But if we consider from the perspective of value it will not seem so. Because it increases the demand for mangos as consumers are getting more mangos at the same rate. Consequently, production and employment both rise in Bangladesh to meet the growing demand which accelerates the country’s economic growth. In brief, devaluation increases exports and decreases imports. When multiple countries devaluate their currencies, it turns into a currency war.

The US-China Currency War: How It Started and What is Going on?

During his presidential campaign in 2016, President Donald Trump kept an envision forth which is ‘Make America Great Again’. By this, he wanted to eradicate the employment problem and reduce the trade deficit of the United States. As China was the top trading partner and the exporter of the US, China grabbed a huge market share of the United States which affected the US’s employment, production, and trade balance. The following graph shows the trade deficit in goods with China of the US from 2011 to 2019. The graph indicates that since 2011, the trade deficit was in a continuously growing position until though it declined a little in 2016. From 2018 to 2019, the trade deficit of the US in goods with China declined dramatically. In 2020, till July, the trade deficit is $163,336.90.

Figure 01: US Trade Deficit in Goods with China
(Source: United States Census Bureau, 2020)

China also encountered by imposing tariffs on the US products. But as the US exports fewer goods to China, and imposing tariffs on the US products will affect the ‘Made in China 2025’ national strategic plan, China encountered the trade war by devaluing its currency. For devaluing its currency sharply, Chinese products became cheaper than the US’s neighboring country Mexico and Canada. As a result, the US consumers started buying Chinese products more which accelerated economic growth in China by rising domestic production and employment. The following graph shows the exchange rate of the Yuan against $1.00 from 2003 to 2020.

Figure 02: Dollar Yuan Exchange Rate
(Source: IMF, 2020)

There are several ways by which a country’s central bank can devalue its domestic currency like printing money more or by buying bonds etc. The main goal is to spread money in the market as much as possible so that it exceeds demand. Because when the demand for holding a currency exceeds, it becomes less valuable to hold. It is just a simple demand and supply theory! But it is found that the Chinese government devalues its currency by opening several shell companies. Those shell companies release the Yuan by purchasing dollars. This artificial way of currency devaluation leads to a shortage of dollars and an excess of Yuan. For gaining an unfair advantage by artificially devaluing currency, the US government labeled China as a currency manipulator.

 

e-RMB: Why is it a Matter of Concern?

China’s digital yuan “provides a functional alternative to the dollar settlement system and blunts the impact of any sanctions or threats of exclusion both at a country or company level”

-Yi Gang (Governor, People’s Bank of China)

The electronic Renminbi or e-RMB is a digital cryptocurrency of China that can change the world of finance forever by allowing China to replace the dollar as the reserve currency and dominate financially in the world. We all have already heard about bitcoin, right? E-RMB is like so. But there is a difference between these two cryptocurrencies. Bitcoin is a digital currency that allows individuals to transact money without any cost, freely, and in a decentralized way. There is no monetary authority in this digital currency system. Anyone can transact any amount anywhere in the world without the interference of any authority and most importantly anonymously. At first, fearing to loss of governance and control over currency and transaction, China wanted to ban cryptocurrency in the country. But observing the growing popularity of bitcoin in China, the Chinese government planned to develop its own digital currency where the central Bank of China will have the utmost controlling and monitoring authority. In the cash system, it is often difficult to monitor money transactions and outflow. But this digital currency system will allow the People’s Bank of China to monitor, record, and detain every transaction and to control currency outflow. Having such a sovereign digital currency will help China circulate money more and easily and will give the opportunity to replace the dollar as a reserve currency. According to an article by the assistant professor Lao of Nanyang Technological University, China has already started e-RMB’s trial in Shenzhen, Suzhou, Chengdu, and Xiong’an. Civil servants are paid a portion of their salary in digital yuan. The participants of the digital yuan will be able to spend in some selected retailers like McDonald’s or Starbucks. Now, China is planning to spread the use of digital yuan or e-RMB in national transactions gradually to reduce the dependence on the dollar peg system.

Mission De-dollarization

Recently, in March 2020, Russia, China, India, and Pakistan along with other central Asian countries signed an agreement in the Shanghai Cooperation Organisation to conduct bilateral trade, investments, and issue bonds in national currency bypassing the dollars. It is a reaction to the misuse of sanctions by the US; especially by the Trump administration. During the Covid-19, the US placed sanctions on many countries like China and Iran which affected those country’s economy and trade. In 2014, after the annexation of Crimea by Russia, the US imposed sanctions on Russia. Since then, Russia was planning to reduce its dependency on the dollar. After the inception of the US-China trade war, China was also looking for an alternative that will reduce its dependency on the dollar and will increase the use of yuan. Consequently, China and Russia agreed to use national currency in bilateral trading. The following graph shows a sharp decline in the usage of the dollar in bilateral trading between Russia and China. In 2020, the share is only 46%.

Figure 03: Dollar Share of China-Russia Trade Settlements
(Source: Financial Times, 2020)

Though this de-dollarization process is so easy as the US has three advantages like limited inflation and depreciation, the largest domestic economy, and a deep and liquid financial market. But experts say if several countries continue their bilateral trade in their national currency, it will be possible to reduce dependency on the dollar.

What is Bangladesh’s stake in this currency war?

According to a report in the Daily Star, the trade war or the currency war between the US and China can be a blessing for Bangladesh. It says as, after the inception of the trade war between the US and China, the US has lost its top exporter and its cheap labor market. Hence, the country will shift to other cheap labor markets like Vietnam, Malaysia, Bangladesh. The report mentions that Bangladesh has the cheapest labor expense among these three alternative countries. So, there is a good opportunity for Bangladesh to take the advantage of this trade war. But another report of the Business Standard says because of having poor infrastructure, working conditions, and inefficiency Bangladesh may lose the opportunity. But it is expected, if Bangladesh can manage all these infrastructural problems and inefficiency, the trade war surely will make Bangladesh benefited.

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