New tariffs between the U.S. and China were announced this week. It seems that U.S. strategy is to continue to increase tariffs until China agrees to our terms. China has fired back with $60 billion of new tariffs of its own on U.S. goods.

But, as investors know, no trade war ends without unintended consequences.

Interestingly, Chinese Premier Li Keqiang has vowed that China won't weaponize its currency, meaning that the country will not deliberately weaken its currency to help its exporters. That being said, the Chinese Yuan (CNY) has already weakened by almost 10 percent this year. As the CNY is a quasi-fixed currency, understandably some observers may be skeptical about Li's commitment.

But in all fairness, most of the sell-off in the CNY happened before mid-August, and in recent weeks the CNY has indeed stabilized.

So, is China's intention to appease President Trump?

As we have mentioned previously, a fixed-rate regime is typically established in smaller, less-developed countries. China is no longer that, so they likely know that their quasi-fixed system cannot continue forever.

The bigger issue, however, is to understand what global imbalances the undervalued CNY has created over the decades. Some results were China's huge trade surplus, its export-driven economy and a huge accumulation of foreign exchange reserves (primarily in U.S. dollars and U.S. Treasuries) by the Chinese government. On the other side was the huge trade deficit with the U.S., where a heavily consumer-driven economy became dependent on cheap Chinese labor and goods, along with lower-than-normal long-term interest rates, resulting in a leveraged society.

My View: By announcing that it won't weaponize its currency, China could correct this global imbalance. Correction of global imbalances have short-term and long-term results, and the outcomes may be quite different.

In the short-run, the U.S. could continue to slap tariffs on cheap Chinese goods, which can adjust the trade imbalances. The shortage of cheaper Chinese goods and labor may temporarily be offset by the administration's recent tax cut, so this imbalance may not feel too painful for now.

In the longer run, if China is no longer supporting a weak CNY, the Chinese government will have to lighten up its U.S. Treasury holdings, resulting in higher U.S. Treasury yields. This seems to be happening already, as the 10-year US T-Bond yield is now comfortably above 3 percent. If Chinese exporters are no longer supported by the currency, they will be forced to become more efficient in managing their companies. In fact, China has already mapped its long-term economic plan to become more efficient, self-dependent and consumer-driven. They seem to almost view the current trade tariffs and exchange rate correction as a process that may hasten this process: Indeed, they have already announced accelerated infrastructure spending and reforms.

The question is: Is the U.S. positioned to face the correction of this global imbalance in the longer-term? Higher import prices and mortgage rates will eventually put a brake on our consumer-driven economy. How will companies substitute cheaper input costs if cheap labor and import prices become less available? Will Americans save more, so that banks have more deposits to lend out to sectors invested in infrastructure spending? The key will be for the U.S. to outline a clear, long-term vision and not be too hasty in correcting for the short-run only.

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