If You Thought the Trade War is as Bad as it Can Be … Get Ready for a Currency War

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Whether by design or dint of investors’ view of a currency’s true worth in the wake of tariffs, emerging-market currencies are sliding — in some cases, fast.

The Turkish lira is by far the most dramatically impacted, as the escalating tariff standoff with the U.S. has hastened an already weakening currency toward a 40% decline, according The Economist reported.

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Source: Bloomberg (via The Economist)

Some suggest that global emerging-market currency weakness is a direct cause of the slide in the Turkish lira, but that is too simplistic.

Yes, the lira’s slide has set a very negative tone for emerging-market currencies, but the backdrop of rising dollar strength predates the spat between the Washington and Ankara.

According to The Week, India’s currency fell to an all-time low this week, reaching 70 rupees against the U.S. dollar. The South African rand and Argentinian peso have also seen big drops in recent days.

The devaluation of the rupee has led to fears the “Fragile Five” economies — composed of Brazil, India, Indonesia, South Africa and Turkey — which overly rely on growth fueled by foreign investment are all vulnerable to a debt default crisis.

Some analysts are warning the market could increasingly look at the five as a single asset class and apply the same negative attitude to all of them. That would be despite some, like India, having comparatively limited external foreign debt and good control of inflation and fiscal balances, compared to, say, Argentina, where the central bank unexpectedly lifted its main interest rate by another 5% points to an eye-watering 45% to support the currency.

The rise came after the Argentine peso had fallen for a sixth consecutive day to hit a record low against the dollar. Argentina not only has significant foreign currency denominated debt but poor fiscal control of the economy and weak banks make them very susceptible to a currency crisis.

Emerging-market stability is one thing; in itself it has the potential to create a crisis. Of more worry, however, is the potential for a global currency war, as America’s opponents either deliberately weaken their currencies to counter the impact of tariffs or tacitly allow the market to devalue the currency by not stepping in to support a slide.

The Chinese yuan has already slid 9% since April. This alone has more or less countered the 10% import tariff on aluminum and significantly mitigated the 25% tariff on steel goods into the U.S. for Chinese exporters.

According to aforementioned Economist article, there are fears that if the U.S. slaps tariffs on a further $200 billion of tariffs on Chinese exports, the yuan will slide by a further 5-6% over the coming months to a 15% devaluation. That would not only help Chinese exporters cope with the tariffs, it would put U.S. exporters at a severe disadvantage.

As the yuan (and other currencies) are sold, sellers move funds to safe havens – namely the dollar, further fueling the dollar’s rise. As the yuan falls, it drags down other Asian currencies, as its neighbors allow their currencies to weaken to maintain some degree of parity and continued access for their exporters to China.

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Weakening emerging-market currencies, particularly the yuan, would be seen by Washington as a hostile act, not an inevitable consequence of the tariffs, and in itself may spark further retaliatory action.

It has to be said, so far Beijing does not appear supportive of a weakening currency, but that may change if its trade war with the U.S. escalates.

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