Has China Devalued? The Euro as a Dollar Alternative
This post features two recent currency-market discussions: a) China's exchange rate response to U.S. tariffs and b) proposals to strengthen the euro as an alternative to the dollar for those global investors seeking safe assets.
1) Michael Spencer, responding to the question of whether China would devalue its currency to counteract tariffs (devaluing makes Chinese goods cheaper for U.S. buyers, thereby offsetting tariffs), argued that it already has, for all practical purposes.
On which Robin Brooks commented:
The problem with this view is that a trade weighted fall in the CNY due to a falling Dollar does nothing to fix the pressure on China’s economy from US tariffs. Only a bilateral devaluation of CNY against the Dollar can do that. So - by leaning against depreciation - China’s policy makers are de facto choosing deflation over devaluation. Seems a highly problematical choice to me…
To which Spencer replied:
Correct. My view is that they know there is nothing they can do to offset the US tariffs. They are simply too high for an exchange rate adjustment to be possible. So they’ll take the depreciation versus non-US markets and use fiscal policy to support it.
And that's a good summary of where things currently stand with the dollar/yuan exchange rate.
2) Tariffs, increasing use of sanctions, threats to tax earnings on foreign-held U.S. assets (Section 899 of the OBBB), and a general perception of decline have led to renewed doubts about the dominance of the dollar. For many good reasons, however, as explained in many of my previous posts, "There is no alternative" (TINA). That hasn't stopped some leading figures in Europe from talking up the euro as at least a partial replacement for the dollar in its roles as dominant trade vehicle and reserve "safe asset" currency. One of them is European Central Bank president Christine Lagarde. Joakim Book is quite skeptical.
https://thedailyeconomy.org/article/but-lagarde-europe-is-a-museum/
In a less pessimistic vein, Luis Garicano examines proposals for Europe to create a true Eurobond market to rival the U.S. Treasury market as a destination for funds seeking a safe haven. The obstacles are high but Garicano believes he has found a way forward toward that goal. It involves further development and strengthening of an earlier proposal for "Esbies," sovereign bond-backed securities.
On the same topic, creation of a deep euro-denominated bond market, Pierpaolo Benigno points out that the project comes with major costs, both financial and political, requiring institutional change and long-term commitment.
