Yuan at 11-year low: Why the Chinese currency is becoming weaker

The trade war between US and China just got murkier. Four days after US President Donald Trump threatened to impose 10% tariffs on $300 billion in Chinese imports, China decided to let its currency yuan fall to an eleven-year low below 7 per dollar on Monday.

Devaluing the yuan will lead to Chinese exports becoming more competitive or cheaper. This will in turn reduce the effects of additional tariffs imposed by US on Chinese imports as part of the ongoing trade war. But the devaluing of currency will also make imports into China more expensive, increasing inflation in an already slowing economy.

The weakening of yuan will also lead to massive capital outflows from the economy.

On Monday, the People's Bank of China (PBOC) said the slump in the yuan was driven by "unilateralism and trade protectionism measures and the imposition of tariff increases on China". This was a reference to Trump's threat to impose tariffs from September 1 on the $300 billion in Chinese imports to the United States in addition to the $250 billion he's already targeted.

This is not the first time China has resorted to currency devaluation. In 2015, People's Bank of China devalued its currency to its lowest rate against the US dollar in three years, to counter its falling growth rate. The central bank in a statement said the move was designed to support market-reforms.

After financial markets closed Monday, the US Treasury Department announced that it was labeling China a currency manipulator for the first time since 1994.

Also Monday, China's official Xinhua news agency reported that Chinese companies have stopped buying US farm products - a direct shot at Trump supporters in rural America.

Together, the currency devaluation and suspension of farm purchases suggest that China has decided to stand tough, rather than cave into Trump's threats.

The Chinese currency hit 7.0391 to the dollar by late afternoon, making one yuan worth 14.2 cents.

"The thought of a currency war is crossing more than a few traders' minds," Stephen Innes of VM Markets said in a report.

Trump promptly took to Twitter to denounce the move as "currency manipulation." He added, "This is a major violation which will greatly weaken China over time."

The weakness of the yuan, also known as the renminbi, or "people's money," is among US grievances against Beijing. American officials complain that a weak yuan gives Chinese exporters an unfair price edge in foreign markets and helps swell the massive US trade deficit with China.

Edited by Aseem Thapliyal

With agency inputs