China Hits Back at Trump by Weakening Yuan, Halting Crop Imports

China responded to Donald Trump’s tariff threat with another escalation of the trade war on Monday, letting the yuan tumble to the weakest level in more than a decade and asking state-owned companies to suspend importsof U.S. agricultural products.

China Hits Back at Trump by Weakening Yuan, Halting Crop Imports

The moves are likely to further antagonize Trump, who has criticized Beijing for managing its currency unfairly and failing to keep promises to buy more U.S. crops.

Stocks and emerging-market currencies sank on concern a prolonged conflict between the superpowers will weigh on global economic growth, while haven assets including the Japanese yen, U.S. Treasuries and gold climbed. Investors increased bets on Federal Reserve interest-rate cuts.

"It’s among the worst-case scenarios," said Michael Every, head of Asia financial markets research at Rabobank in Hong Kong. "First markets sell off, then Trump wakes up and this all gets far, far worse."

The White House didn’t immediately respond to a request for comment.

Trump last week proposed adding 10% tariffs on another $300 billion in Chinese imports from Sept. 1, abruptly ramping up the trade war between the world’s largest economies shortly after the two sides restarted talks. Chinese bureaucrats were stunned by Trump’s announcement, according to officials who’ve been involved in the negotiations.

The threat of more tariffs came just as Chinese President Xi Jinping and other senior members of the Communist Party gathered for a secretive summer getaway in Beidaihe, a seaside town about a three-hour drive from Beijing. Xi had already faced pressure for weeks to take a harder stance in trade talks -- particularly after the U.S. blacklisted telecom equipment giant Huawei Technologies Co.

Editorials in state-run newspapers suggested Xi will reject any deal that either retains punitive tariffs or forces China to make concessions on issues like state-run enterprises that could weaken the party’s grip on power.

The harder line underlines a growing feeling in Beijing that Trump can’t be trusted to cut a deal, and that China would be better off waiting to see if a Democratic presidential candidate -- many of whom have criticized the use of tariffs -- takes office. The halt in agricultural purchases could hurt Trump in politically sensitive states ahead of the 2020 election.

The MSCI Asia Pacific Index headed for its biggest decline since March on Monday, with shares slumping more than 2% in markets from Tokyo to Hong Kong and Seoul. Equities in Shanghai saw a more modest drop amid speculation that state-linked funds may act to prop up the market, while U.S. equity-index futures dropped 1.1%.

The yuan tumbled 1.3% to 7.0324 a dollar at 2:42 p.m. Hong Kong time, after the People’s Bank of China set its daily reference rate at a weaker level than 6.9 for the first time since December. The offshore yuan sank as much as 1.9% to a record low.

China's yuan weakens past 7 per U.S. dollar for first time since 2008

"Breaking seven is due to a mix of factors: an escalation of trade war, the softening of China’s economy and a willingness for the PBOC to tolerate higher volatility for the yuan," said Larry Hu, head of China economics at Macquarie Securities Ltd. in Hong Kong. "The PBOC has entered uncharted waters, so it has to manage expectations carefully."

The central bank attributed the yuan move to protectionism and expectations of additional tariffs on Chinese goods, while saying it can still maintain a steady currency.

By linking today’s devaluation with the renewed tariff threat, the PBOC "has effectively weaponized the exchange rate," said Julian Evans-Pritchard at Capital Economics in Singapore. "The fact that they have now stopped defending 7 against the dollar suggests that they have all but abandoned hopes for a trade deal."

Allowing the yuan to weaken is not without risk for China. A mid-2015 devaluation spurred capital outflows and destabilized global markets, though tighter capital controls this time around should help prevent another exodus.

A cheaper currency also risks triggering yet more reprisals from the U.S. president, who has frequently warned that tariffs could go much higher. At a rally in Cincinnati last week he boasted of "taxing the hell out of China" until there’s a deal.

The biggest damage from the trade war is the hit to business activity and confidence that comes from increased uncertainty, rather than the tariffs themselves, according to Wang Tao, China economist at UBS Group AG. For that reason, the weaker yuan may do little to offset the blow, she said.

China’s crop imports from the U.S. are another weapon at Beijing’s disposal. The country’s state-run agricultural firms have now stopped buying American farm goods, and are waiting to see how trade talks progress, people familiar with the situation said, declining to be identified as they’re not authorized to speak to the media. Corn and soybean futures fell on the news.

When he announced the trade truce last month, Trump spoke at length about how China would be buying more farm goods from “great patriots” in the Midwest -- even though no details of any purchases have been announced by either side. Officials in Beijing privately said afterward that China made no promises to buy more agriculture goods before a final deal is struck.

China’s commerce ministry didn’t respond to a fax seeking comment.

"China is giving up on its softer diplomatic strategy and is no longer willing to be Trump’s punching bag," said Chua Hak Bin, an economist at Maybank Kim Eng Research Pte. "Trump’s tariffs threats are backfiring and triggering a full-scale trade war."

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