The Renminbi Should Not Be Weaponized in a Trade War

The yuan has weakened against the US dollar of late. On July 3，the onshore spot rate slipped to 6.71，the lowest level since August 2017. Some observers contend this is the Chinese government's response to the imposition of new tariffs by the US. I disagree with this view. The yuan's weakness has not been the result of policy guidance. Moreover，the currency will not depreciate to a large degree as a result of policy direction in the future.

Some observers see yuan depreciation as an important weapon to be used to boost exports in a trade war with the US. But the argument for using this weapon is weak. From January to May this year，China's foreign trade performance was relatively good. Although trade frictions could hurt exports in future，the impact is likely to be limited even without help from a weaker currency.

In 2017，for example，the yuan's value rose more than 6% against the dollar，but exports still climbed nearly 11% due to the recovery of the global economy. During the period of yuan weakness from 2014 to 2016，exports performed poorly due to a sluggish external environment. If China decides to allow a small depreciation of the yuan，the effect will be limited. If it chooses to permit a bigger depreciation，that could trigger similar moves by other countries，and that would offset some of the benefits to Chinese exporters.

In addition，it is useful to recall the market panic caused by the small devaluation of the currency in 2015. The one-off move was followed by an extended period of yuan depreciation，exacerbating capital outflows. That in turn undermined the Chinese government's efforts to stabilize the exchange rate and promote the internationalization of the currency. A larger depreciation of the yuan would weaken domestic purchasing power and hurt consumer confidence. It would also transmit concerns to the housing，stock and bond markets，increasing the potential for systemic risks.

A new round of yuan depreciation would add fuel to the fire in the Sino-US trade war. China should fight back by making proportionate responses that will convince the US to return to the negotiating table and try to reach a compromise. China needs to emphasize the fact that a trade war ultimately hurts both sides. Opening up new areas of conflict will only worsen the problem.

It is worth noting that there have been signals from policy makers that the exchange rate should not be used as a weapon in a trade war. Yi Gang，governor of the central bank，stated that the recent swings in the foreign exchange market are mainly a reflection of pro-cyclical factors，such as the strength of the US dollar and external uncertainties. He added that China will maintain the basic stability of the yuan at a reasonable and balanced level. Guo Shuqing，chairman of the China Banking Regulatory Commission，said that the yuan has entered a period of two-way fluctuations within a reasonable range. Economic fundamentals suggest that a significant depreciation of the yuan is not likely. As a new international reserve currency，the yuan is likely to strengthen in the future.

Dollar Strength

Looking at currency trends of the rec