The stock market is getting hit hard because China decided to use a weapon to hit back against President Trump’s new tariffs: the yuan.
By midafternoon, the Dow Jones Industrial Average had dropped 3.1%, while the S&P 500 (.SPX) had fallen 3.2%, and the Nasdaq Composite (.IXIC) had slumped 3.8% to 7826.14. Foreign stock markets aren’t doing any better. Britain’s FTSE 100 (.FTSE) closed down 2.5% and Japan’s Nikkei Stock Average fell 1.7%, while the Shanghai Composite lost 1.6%.
The value of a currency is an abstraction. Investors don’t really want paper with pictures of politicians printed on it; they want what it allows them to buy: local assets. At the most basic level, investors can’t pay for U.S. stocks and bonds, for instance, with euros. They have to get actual dollars to complete any U.S. transaction.
Currency “prices” are only quoted relative to another, so currency values float on a sea of relativity, bobbing up and down because of factors like economic growth and interest rates.
Chinese officials don’t let the market alone determine the value of their currency, the yuan. They keep it within a band of values, and now Beijing has taken the step of allowing the yuan to weaken beyond the psychologically key level of 7 to the dollar.
The immediate impact of the move is to nullify the impact of the new tariffs announced by the U.S. last week. The price for imports from China, quoted in U.S. dollars, just went down. After the new tariffs take effect on Sept. 1, importers in the U.S. will be left paying more or less the same amount as if the U.S. hadn’t acted.
A similar thing happened to the Mexican peso after the 2016 U.S. election, although unlike the yuan, the peso isn’t controlled by the government. The market sold pesos, driving its value down almost 20%, effectively wiping out the impact of threatened tariffs. Don’t forget. The president made exiting the North American Free Trade Agreement a campaign promise. The U.S. did exit the trade pact, but a new deal was negotiated without punitive tariffs being put in place.
U.S. consumers like a stronger dollar. It makes things cheaper. But with new tariff duties, shoppers aren’t likely to see much benefit from a mightier greenback.
U.S. exporters don’t like a stronger dollar. It makes U.S. goods less competitive against foreign products.
What does the U.S. export? Machinery, movies, agricultural goods, and planes, among myriad other products. More than a third of sales of large U.S.-based industrial enterprises are generated from overseas markets, according to Barron’s math.
U.S. stock-market investors don’t like the uncertainty tariffs brings. That can hurt valuation multiples, as well as expectations for future profit growth. All else being equal, profits generated in China won’t be worth as much to U.S. investors. And, again, all else being equal, lower profits in U.S. dollars mean lower U.S. stock prices.
The tariff topic is coming up on nearly every earnings conference call. It also came up when Barron’s spoke with General Electric (GE) CEO Larry Culp last week. Management teams have mitigated the impact of tariffs on their operations, for the most part, by shifting production and cutting costs. Culp’s answer to the tariff question sums up what most managers are saying: He is trying to control the things he can control, nothing more.
The problem is that is getting harder to do.
|For more news you can use to help guide your financial life, visit our Insights page.|