China's currency may be caught in a downward spiral of international pressures as the country tries to avoid the threat of retaliatory trade measures from the United States next year.
After depreciating steadily against the U.S. dollar for much of 2016, the yuan renminbi (RMB) suffered an accelerated decline last month, hitting a series of eight-year lows with a string of daily losses.
Last week, the currency rallied and recovered some of its lost ground after the government stepped in and imposed new capital controls to hold back an avalanche of outflows.
But the nearly two-percent drop for the month was the largest since the surprise devaluation of August 2015 threw foreign stock markets into turmoil, The Wall Street Journal reported.
So far this time, international markets have taken the depreciation in stride.
That may reflect recognition that the latest slide in the yuan's value has been fundamentally different from the August devaluation and another abrupt adjustment last January that has yet to be fully explained.
While those earlier erosions were initiated by the People's Bank of China (PBOC), this decline has been driven by a jump in the dollar to a 13-year high against other currencies.
The previous devaluations may have been partly aimed at making China's exports more competitive, but there have been signs that the PBOC has tried to support the yuan this time against a steeper falloff.
On Nov. 8, the PBOC reported that its foreign exchange reserves dwindled in October to U.S. $3.12 trillion, marking the fourth monthly loss in a row.
The yuan has been dragged down for months by expectations that the U.S. Federal Reserve will raise interest rates, a decision that has been repeatedly delayed during the past year.
If and when the rate hike does come, dollar investments will become more attractive while the PBOC's policies will stay geared to supporting China's "new normal" of slower economic growth.
The Trump effect
Gary Hufbauer, senior fellow at the Peterson Institute for International Economics in Washington, said pressure on the yuan has been increased by anticipation of new U.S. policies from President-elect Donald Trump.
As a candidate, Trump campaigned on promises of major tax cuts and infrastructure spending to stimulate the economy and spur employment.
"There's a general expectation that Trump's policies will lead to a substantial increase in the fiscal deficit and thus an increase in interest rates and a big ramp-up in trade deficits and the value of the dollar simultaneously," Hufbauer said.
The result is likely to be even greater pressure on the yuan as the dollar continues to strengthen.
Trump supporters deny that his infrastructure plans will have negative consequences, citing the boost for the economy and new jobs.
In a campaign paper, Trump senior policy advisers Wilbur Ross and Peter Navarro argued that the spending will be "revenue neutral," since it will rely on leveraging public- private partnerships, tax incentives to reduce equity costs and funding from revenue-producing bonds.
Ross was named as the Trump administration's choice for secretary of the Commerce Department last week.
China may try to keep the yuan from falling further in hopes of avoiding retaliatory steps.
In a key pledge, Trump has promised to label China a "currency manipulator" on the first day of his presidency in January. During the campaign, he also threatened to impose tariffs of up to 45 percent on imported Chinese goods.
The currency and trade issues could upset a delicately balanced relationship with China, which may already be unsettled by reactions to the president-elect's phone contact with Taiwan President Tsai Ing-wen last week.
Trump has pointed to the record U.S. trade deficit with China of $367.1 billion (2.5 trillion yuan) last year as a major cause of job losses.
"The fact that the RMB is falling rapidly against the dollar will certainly be seized on by the new people in the Trump administration as evidence of currency manipulation by the Chinese, even though it seems to reflect capital outflows from China, not inspired by the PBOC," Hufbauer said.
This year, the U.S. trade deficit with China is down 6.3 percent through September from the 2015 record pace, according to U.S. Census figures cited by the Associated Press.
Based on China's 10-month customs data, the country's trade surplus with the United States has dropped nearly 5 percent from a year earlier in dollar terms, Bloomberg News said.
But the marginal improvement due to weaker Chinese exports may cut little ice with the Trump administration after years of complaints about unfair trade practices. The U.S. trade deficit with China has nearly tripled since 2003.
Why the latest plunge?
In a blog posting for the Washington-based American Enterprise Institute, resident scholar Derek Scissors outlined two possible explanations for yuan's latest plunge.
"The dollar has been strong. The question is: why isn't the RMB at least as strong?" Scissors said.
One interpretation is that China's official figures have overstated the economy's growth.
"The Chinese economy is in truth considerably weaker than the American economy and the value of the yuan reflects that," he said.
The alternate explanation is that the PBOC has deliberately devalued the yuan again to make exports more competitive.
In that case, "it's more likely the sliding yuan will only strengthen those Trump advisers calling for immediate economic action against China," Scissors said.
Both the administrations of President Barack Obama and his predecessor George W. Bush have repeatedly stopped short of charging China with currency manipulation in semiannual U.S. Treasury reports, despite bipartisan support in Congress for retaliatory measures in the past.
But the United States has imposed numerous anti-dumping tariffs on Chinese products including aluminum and steel, citing illegal subsidies, while pursuing a series of cases before the World Trade Organization (WTO).
Despite the option of more targeted approaches, the United States and China could be headed toward a confrontation over the currency issue.
One reason is that the yuan is likely to be headed lower, even if the PBOC tries to slow the decline.
China's slower economic growth and the stronger dollar may have already set the stage for a spiral of downward pressures.
Capital has been leaving the country seeking higher returns, much of it in the form of outbound investment, which the government is now seeking to control after sharp increases this year.
Non-financial outbound direct investment soared 53.3 percent in the first 10 months to U.S. $146 billion (1 trillion yuan), according to Ministry of Commerce figures.
China and its partners may see the surge as a sign of economic strength, but the outflows also suggest capital flight.
The pace of outflows may further erode confidence in the yuan. If the PBOC seeks to shore up the currency's value, its reserves may fall further, dragging the yuan down even more.
"The lower that reserve number goes, then the more doubt about the banking system," said Hufbauer. "It's a downward spiral."
Period of fluctuation
Even the reports in China's state media have raised expectations of weakening.
"It is not easy to forecast when the yuan's exchange rate level will bottom out during this period of fluctuation," said Guan Tao, former head of the international payments department at the State Administration of Foreign Exchange (SAFE), as quoted by the official Xinhua news agency.
Chinese officials have argued that the yuan remains relatively more stable against a basket of currencies. But some analysts expect the PBOC will mount a defense of the yuan before it falls below the psychological barrier of seven to the dollar, the South China Morning Post reported.
Xinhua has also suggested that the PBOC may act preemptively with a large enough devaluation to put a floor under the daily erosion of the currency.
Hufbauer warned that such a big step would have consequences.
"You can imagine how that would be read over here," he said.
China's official press has repeatedly offered assurances that the country's economic fundamentals are sound.
"There is no basis for a sustained depreciation trend for the yuan, and we maintain the forecast of 6.98 (yuan to the dollar) for the end of 2017," said Huili Chang, an analyst at China International Capital Corp., quoted by Xinhua.
Hufbauer said that analysts at the Peterson Institute are persuaded that the incoming president will follow through on his promise to brand China as a currency manipulator, but they are optimistic that the resulting penalties will be less than an across-the-board tariff of 45 percent.
Options include support for more trade remedies, either through individual anti-dumping tariffs or more generalized "safeguard" cases for entire industries like steel. The remedy route might also involve more cases brought before the WTO.
The new administration is expected to deny recognition to China as a market economy under its WTO accession agreement, making it easier to keep imposing anti-dumping measures.
Hufbauer also suggested that the administration could support legislation that would treat currency undervaluation as a subsidy, allowing tariffs on a wide range of Chinese products.
But he argued that across-the-board tariffs would invite retaliation from China, leading to a trade war that would damage both countries and disrupt supply chains for manufacturing.
Trump is likely to avoid trade measures against China that may threaten U.S. jobs, said Hufbauer.
"I don't think he'll go over the line that triggers big- scale retaliation by China, purely for domestic reasons," he said.