financial monetary theory foreign exchange rate during trade war between us china

However, Our research concentrates on foreign exchange rate and factors affecting exchange rate in the short run and in the long run and forecast the effect of US-China trade war to the

HANOI UNIVERSITY

FACULTY OF MANAGEMENT AND TOURRISM

FINANCIAL MONETARY THEORY

FOREIGN EXCHANGE RATE DURING TRADE WAR BETWEEN US - CHINA

Tutorial; TUT 2 AC Tutor: Dao Mai Huong

Group members: Hoang Thi Anh - 1704010009 Nguyen Thi Nha — 1704010078

Ngo Huyen Nga - 1704010073

Ta Ngoc Tram — 1704010120

Vu Ha Trang — 1704010119

Ha Noi, 2019

Abstract

Trade war between US and China is the hot topic in recent years because they are two largest economies in the world; hence, trade tension between them escalating has negative impacts on the worldwide economy and the particularly affects these two countries first However, in this research, the impacts of the trade war on exchange rate between US and China are highly focused Specifically, the context of trade war will be shown and then, the factors affecting exchange rate in long run and short run will be discussed Finally, the further forecast of exchange rate will be given in the end of the research.

HH Effects of US - China trade war to the value of U.S Dollar versus Chinese Yuan 3

IV) Forecast the effect of US - China trade war to the value of U.S Dollar versus Chinese Yuan 9

1D Introduction

According to US news, the United States and China includes in top nine countries as being the

most powerful all over the world; the US has a larger nominal GDP, whereas China has a larger

GDP when measured in terms of PPP China - the world's largest exporter and the United States as the world's largest importer They have so far been important pillars for the global economy It is remarkable that in July 2018, these two countries get into tiffs over a pungent trade encounter Over the past year, the world's two largest economies have imposed tariffs on billions of dollar worth of one another's goods.US President Donald Trump has long accused China of unfair trading practices and intellectual property theft Meanwhile, in China, there is a perception that the US is trying to curb its development The current trade war is creating more economic uncertainty, which makes many companies suspend development, reducing spending to avoid risk In addition to that, tariffs increase price, reduce import and export and consumption The next unavoidable consequence is that the economy will shrived up This situation happens in both the United States

and China This event attracts a huge concern of both these two countries others Also, there are many researches to analyze how The US and China trade war affects the political and economic

components such as the research of the impact of the US and China trade war to the global

economy and Vietnam (Nguyen Le Dinh Quy, 2018), The Trade War between China and US

(Zeyan Zhul, a, Yaotang Yang?, *b and Shuqi Feng2, cl, 2School of Business Administration ,

Hohai University, Changzhou 213000, China) However, Our research concentrates on foreign

exchange rate and factors affecting exchange rate in the short run and in the long run and forecast

the effect of US-China trade war to the value of U.S dollar versus Chinese Yuan

IL) Overview of US - China trade war

According to The Balance, trade war is when a nation imposes tariffs or quotas on imports and foreign countries retaliate with similar forms of trade protectionism As it escalates, a trade war reduces international trade Since 2016, US- China trade war has become the world’s spotlight On the Presidential campaign trail of 2016, Donald Trump said US had a 2016 trade deficit more than $300 billion Specifically, in 2018, the U.S goods and services trade deficit with China was US$378.6 billion, whereas the U.S imported US$539.5 billion from China and exported to China only US$120.3 billion in goods and services (Office of the United State trade representative,

2018) Additionally, Trump realized that the trade deficit between US and China has been increasing since China participated in WTO, from 100 billion USD in 2001, to 375 billion USD in 2017; therefore, he wants to compensate for this shortage He also wants to deter China from becoming a leader in terms of technology in the world Consequently, Donald Trump promised to

increase tariffs on Chinese goods that were imported from China Therefore, in 2018, a sequence of events occurred between US and China They enacted tariffs on each other to retaliate the other

The most recent event is that the US increased tariff from 10% to 25% worth of US$200 billion of

Chinese goods on 10/5/2019 To retaliate the US, China also increased tariff from 10% to 25%;

however, this amount of goods only had worth of US$60 billion The trade war between US and China had created many consequences on both largest economies and other related countries Nevertheless, the direct effect that will be discussed on this report is the change in the value of the US dollar and Chinese Yuan

Imports from China and Exports to China

DEFICIT

200

The sum of imports from China and exports to China from 1985 to 2018

Ill) Effects of US - China trade war to the value of U.S Dollar versus Chinese Yuan

1) Long run effects

1.1 Relative price level

The price level of two countries has been changing a lot since the trade war happened Regarding

China, in June, the consumer price index stayed at 2.7%, which was the highest number in 15

months; however, this number rose to 2.8% in August and quickly to 3% in September It seems that the food price fluctuated widely with the increase of 11,2 % in September — the highest increase of consumer price over the past 6 years, and it made a large contribution to the rise in CPI; meanwhile the non — food prices appeared to be quite stable with only 1.1% Pork prices

have been a major driver in the overall consumer prices They cost twice as much as a year

earlier, by 46,7% during August, at 31- 33 CNY per kilogram, that fueled pork price inflation Due to that, people turned to beef and chicken, which also pulled the price of the meat up Accounting for this modification, African Swine fever has been spreading widely; therefore, over one million pigs are culled in China to prevent this disease from circulating This sparked the drop of pork production — by 5.5%, with only 24.7 tons of pork produced compared with the same period of last year and the shortage of pork The announcement of levying tariffs on soya beans, pork and oil impacted slightly Fresh fruits also saw some changes in terms of their prices Publicized by BNNNT TQ until 23/5/2019, five main fruits in China cost 7.77 CNY/ kg, rose by 32,7 %, in comparison with last year More specifically, the price for each kg of Fuji apples and Korla pear is 24,8 CNY, increase by 75%, 60%, which also pulled up the CPI by 0.22% The rise in input cost due to the tariffs on peach, orange, apple and drought accounted for the supply deficit The increase in CPI corresponds with that in price level; the business may want to narrow down their production scale, Chinese people demand less for domestic goods and more for American ones, the CNY tends to depreciate and the US$ will appreciate.

China CPI & PPI INSIDER

Year-On-Year, China National Bureau of Statistics

~ Táo Fuji Dưa hấu Dua 0 Z— =Nho Jufeng

2019 February March April May

The rise in the price of Chinese fruit during 2019

On the other hand, the goods in USA are also victims of this trade war Auto industry incurred

more expense for its materials because most of them are imported from China, especially steel and other kinds of metal General Motors confessed that they had to cover more expense, over | billion USD are spent to make up for tax and materials Ford is also in the same situation with

GM Hackett — the CEO of this brand said in 26/9/2018 that due to the increase in tariffs on metal,

they lost about 1 billion US$ in revenue Few beverage brands in USA as Coca cola, Boston beer in Massachusetts chose to increase the prices of products to compensate for the tax expense related to metals Cited a report by Research organization of American parliament, the price for each washing machine went up by 12% - compared with 2018 Figures from Nielsen show that prices on a basket of household products, from nappies to bin bags, rose 2.5% in the year to the

4

end of March, more than double the rate of the previous year Food and drink prices rose by less, up 2 percent, from 1.4% increase the previous year As a result, when price level in USA rises, people demand less for domestic goods and tends to yearn for China ones Followed by that, the US$ depreciates and the CNY appreciates

US$200 billion on Chinese goods and US$ billion on US goods

CUOC CHIEN THUE QUAN MY - TRUNG

21.8 —= Thuế quan trung bình của Trung Quốc lên hàng Mỹ (%)

=®= Thuế quan trung bình của Mỹ lên hàng Trung Quốc (%)18.3 Liz

3.1, 38

1/1 2/4 6/7 23/9 1/1 10/5 1/9

2018 2019

Nguồn: PIIE, USTR, Trung tâm Thương mại Quốc tế, Bộ Tài chính Trung Quốc 2

Average US tariff on China and Chinese tariff on US

On average, the tariff that imposed on each other increases overtime Average tariff of the US export to China 21.8% and Chinese export to US is 21.2% However, on reality, some products had already been hit with 25% tariffs According to China Briefing, total the US tariffs applied exclusively to Chinese goods is US$550 billion and total Chinese tariffs applied exclusively to

US goods is US$550 billion Overall, the currencies of both countries are depreciated when they are in the other country.

1.3.Preferences for domestic versa foreign good

When the U.S and China have implemented multiple rounds of increased tariffs on each other's goods, it leads to the change in demands of foreign goods on both two countries Firstly, Chinese import from the US reduces Based on new survey conducted by Brunswick group, 56% of Chinese consumers say they have avoided purchasing an American product to show support for China Some famous American brands are boycotted in China such as: Apple, Starbuck, Mc Donald In 2019, CNBC showed that Chinese imports from America slumped 22.4% Moreover, Chinese enterprises also halted new purchases of American agricultural goods in response to Mr Trump’s decision to impose more tariffs The agricultural products that are banned to import to

China are soybeans, pork, cotton, sorghum, fruits However, soybeans - the product is mostly

affected when China almost completely stopped importing soybeans from the US at the end of 2018 (US Census Bureau, 2019) China is the biggest importer of the world's soybeans so that halting importing that product from the US makes American farmers get trouble When demand for imports goods from US decreases that results in appreciation in Chinese Yuan

SOURCE: US Census Bureau

Spotlight on soybeans in 2018 and 2019

Secondly, Chinese export to US declines From October 2018 to March 2019 is the time of the threat and action of tariffs and counter-tariffs between Washington and Beijing According to

Census Bureau, China’s exports fell sharply at that time and the amount of Chinese exports increased 3 times from $1175.6732 billion to $3478.9294 billion at the time two countries announced to suspend of fighting However, it is still lower on average

55000 52202.3354

SOURCE: TRADINGECONOMICS.COM | U.S CENSUS BUREAU

Amount of Chinese exports to US in 2018 and 2019

On top of that, China’s August exports to the United States fell 16% year-on-year, slowing sharply from a decline of 6.5% in July 2019 (CNBC, 2019) When Chinese export to US falls, Chinese Yuan tends to depreciate At that time, the exchange rate of Yuan is over 7 CNY/USD and the US accused China to manipulate their currency

2 Short run effects

In this analysis, the United States was treated as the home country, so domestic assets are denominated in dollars Meanwhile, Chinese Yuan stands for the foreign country’s currency, so

foreign assets are denominated in Chinese Yuan 2.1 Change in USA interest rate

America experienced a Recession during 2008, and FED decided to decrease the rate to 0.1% so

that it could recover the economy and flee it from the worst period From that time, FED made no reduction — related adjustments in rate However, during the trade war with China since 2016, Fed

cut the rate two times in 2019 For the first time after 10 years, in 31/7/2019, the FED open market

committee voted to lower the central bank’s benchmark rate by 25 basis point ( to the target of 2% -

2,5 %) Nevertheless, this move should not be viewed as indication that there is a pre-set course for

future cuts The second cut was executed in 18/9/2019, it went down by 0.25%; and the rate hovers between 1.75% and 2% Cuts in interest rates in any country tend to make its currency lose value

against others When lower interest rates mean there is less money to be made by investing in that

country's assets, since they're yielding less interest If investors are less keen to buy, there is less demand for the currency needed to buy them The dollar in this case, tends to lose value The dollar

depreciates, and the CNY has tendency to appreciate To elucidate this change, Chairman of Fed — Powell said that the officials took action to remain the strength of economy The policy makers of FED realized that there are some uncertainties and threats which make it on the verge of being in

recession: GDP decreased down to 2.1 % in the second quarter, compared with 3.1% in the first one

of 2019, retail revenue grew with the speed of 4.7% - slower than 2018 with 5.6% Moreover, as mentioned above, the export activities in USA went down over the past few months, which is considered as the consequence of trade war It is one of the determinants leading to the decision of cutting rate

2.2.Change in CNY interest rate

A relatively high interest rate in a host country has a positive impact on inward FDI (Gross and

Trevino, 1996) However, in recent years, China's central bank is cutting interest rates by stealth

"The reform indicates the central bank is trying to tackle a more fundamental issue — making it easier for lower rates to pass through to corporate borrowers," said Hao Zhou, senior China economist for Commerzbank in Singapore Therefore, the decrease of Chinese interest rate has a huge influence to the American investors because of losing returns when they make loans to Chinese companies These investors prefer to lend to American companies, as well as hold more domestics assets It leads to the increase of demand for US dollars and US dollar appreciates

2.3.Change in the expected future exchange rate

During the trade war, the US label China as a “currency manipulator” because it could offset the effectiveness of the tariffs on Chinese goods imported into the United States BofAML predicted that when Trump threatened to slap 10% tariff on $300 billion of Chinese goods starting on the first of September, the U.S dollar-Chinese yuan exchange rate may touch 7.3 by the end of 2019 Moreover, chief economist at Singaporean bank DBS - Taimur Baig said that Donald Trump has caused the U.S dollar to strengthen even more compared to the yuan and other currencies if he