In response to recent US announcement on new tariffs, the Chinese authorities allowed the renminbi to weaken above the symbolic seven yuan versus the US dollar. In turn, this led the US to label the Chinese as currency manipulators. These exchanges might sound like straightforward tit-for-tat but we think they raise the ante, which might mean some investors are too complacent. 
Cast your mind back to the beginning of 2018, when the dominant narrative was that there wouldn’t be a fully-fledged trade war. The conventional wisdom being that the authorities had learnt from past experience that it was not a way to solve economic imbalances, it’s a zero-sum game and can easily escalate.
Fast forward to today and we’re in the middle of a trade war. It’s not surprising that conventional wisdom was wrong but what is surprising is that the very same arguments are being wheeled out to dispel the idea that the current rhetoric will escalate into currency wars: it is no way to solve economic imbalances, it’s a zero-sum game and can only too easily escalate.
Nevertheless, currency can become a policy tool, just like tariffs and quantitative easing (QE). The context is compelling: global growth continues to slow and, in terms of policy responses, QE looks increasingly tired, while the trade war is escalating. Importantly, QE is increasingly perceived as contributing to slowing global growth, as is the trade war.
It is time to look at other policy responses. We have argued for fiscal expansion for some time: interest rates are low, infrastructure deficits are high and, as opposed to QE, it is a direct way to inject money into the real economy. The main obstacle is the prioritisation of an austerity ideology to reduce debt levels and/or to achieve political objectives, such as a smaller role for the state. That said, the austerity argument is losing steam, even though politicians hate losing face.
Nevertheless, there are some signs of a political reset. A story came out of Germany last week around a fiscal U-turn to finance a climate protection programme, while Boris Johnson is sounding more fiscally expansive, with one eye on a general election and the smoothing of a no-deal Brexit. These aren’t more than stories at this stage and being fiscally expansive does feel like a slower burn, particularly compared to the barriers to currency manipulation.
Currency devaluation can be a direct stimulus to economic growth, especially to those economies that are more export-orientated, such as the Eurozone. Importantly, for politicians and their austerity ideology, there is little risk of losing face. Plus, the stretch from QE is not so much, in that its financial market manipulation (this time-limited to a currency) is trying to stimulate economic growth, and let’s not forget that QE had a weaker currency dimension to its impacts anyway. Nevertheless, it does encourage tit-for-tat responses.
That’s not to say that currency wars will take place, just that markets are probably a little too complacent, as they have been over recent policy developments, such as QE and trade wars. More generally, a key question is the degree to which the US authorities will allow the US dollar to strengthen from here.
The implications for financial assets are tricky to assess at this stage. On a general level, it will add another level of uncertainty for companies and investors. More specifically, we would expect gold to benefit in an increasingly uncertain environment, particularly policy uncertainty, and with currencies being debased.
Looking back, QE might well have been the tool that took the worst out of 2007/2008 but then weighed the economy down. Similarly, explicit currency manipulation, if it happens, will likely have short term positive effects too, with negative consequences. More importantly though, while not without risk, we feel we are that bit closer to an inevitable fiscal expansion.
Anthony Rayner is manager of Miton’s multi-asset fund range. The views expressed above are his own and should not be taken as investment advice.