NEW YORK (BLOOMBERG) - China responded to President Donald Trump's tariff threat with another escalation of the trade war on Monday (Aug 5), letting the yuan tumble to the weakest level in more than a decade and asking state-owned companies to suspend imports of US agricultural products.
The moves are likely to further antagonise Mr Trump, who has criticised Beijing for managing its currency unfairly and failing to keep promises to buy more US crops.
"China dropped the price of their currency to an almost a historic low. It's called "currency manipulation." Are you listening Federal Reserve? This is a major violation which will greatly weaken China over time!" Mr Trump wrote on Twitter on Monday.
Stocks and emerging market currencies sank on concern a prolonged conflict between the superpowers will weigh on global economic growth, while haven assets including the Japanese yen, US Treasuries and gold climbed. Investors increased bets on Federal Reserve interest rate cuts.
"It's among the worst-case scenarios," said Mr Michael Every, head of Asia financial markets research at Rabobank in Hong Kong. "First markets sell off, then Trump wakes up and this all gets far, far worse."
The White House didn't immediately respond to a request for comment.
Mr Trump last week proposed adding 10 per cent tariffs on another US$300 billion (S$414.70 billion) in Chinese imports from Sept 1, abruptly ramping up the trade war between the world's largest economies shortly after the two sides had restarted talks.
Chinese bureaucrats were stunned by Mr Trump's announcement, according to officials who've been involved in the negotiations.
The threat of more tariffs came just as Chinese President Xi Jinping and other senior members of the Communist Party gathered for a secretive summer getaway in Beidaihe, a seaside town about a three-hour drive from Beijing.
Mr Xi had already faced pressure for weeks to take a harder stance on trade - particularly after the US blacklisted telecom equipment giant Huawei Technologies Co.
Editorials in state-run newspapers suggested Mr Xi will reject any deal that either retains punitive tariffs or forces China to make concessions on issues like state-run enterprises that could weaken the party's grip on power.
The harder line underlines a growing feeling in Beijing that Mr Trump can't be trusted to cut a deal, and that China would be better off waiting to see if a Democratic presidential candidate - many of whom have criticised the use of tariffs - takes office.
The halt in agricultural purchases could hurt Mr Trump in politically sensitive states ahead of the 2020 election.
The MSCI Asia Pacific Index slid 2.1 per cent on Monday, the biggest drop since October 2018. European shares and S&P 500 index futures also retreated, while the yield on 10-year US Treasuries declined about 8 basis points to 1.77 per cent, the lowest level since 2016.
The yuan weakened 1.7 per cent to 7.0909 a dollar after the People's Bank of China set its daily reference rate at a weaker level than 6.9 for the first time since December.
"Breaking seven is due to a mix of factors: an escalation of trade war, the softening of China's economy and a willingness for the PBOC to tolerate higher volatility for the yuan," said Mr Larry Hu, head of China economics at Macquarie Securities Ltd in Hong Kong.
"The PBOC has entered uncharted waters, so it has to manage expectations carefully."
In a statement, the central bank attributed the yuan move to protectionism and expectations of additional tariffs on Chinese goods, while saying it can still maintain a steady currency.
By linking today's devaluation with the renewed tariff threat, the PBOC "has effectively weaponised the exchange rate", said Mr Julian Evans-Pritchard at Capital Economics in Singapore.
"The fact that they have now stopped defending 7 against the dollar suggests that they have all but abandoned hopes for a trade deal."
Allowing the yuan to weaken is not without risk for China. A mid-2015 devaluation spurred capital outflows and destabilised global markets, though tighter capital controls this time around should help prevent another exodus.
A cheaper currency also risks triggering yet more reprisals from the US President, who has frequently warned that tariffs could go much higher. At a rally in Cincinnati last week he boasted of "taxing the hell out of China" until there's a deal.
The biggest damage from the trade war is the hit to business activity and confidence that comes from increased uncertainty, rather than the tariffs themselves, according to Ms Wang Tao, China economist at UBS Group AG.
For that reason, the weaker yuan may do little to offset the blow, she said.
China's crop imports from the US are another weapon at Beijing's disposal. The country's state-run agricultural firms have now stopped buying American farm goods, and are waiting to see how trade talks progress, people familiar with the situation said, declining to be identified as they're not authorised to speak to the media.
Privately owned Chinese firms that had received retaliatory-tariff waivers on American soybeans from Beijing have also stopped buying the commodity due to uncertainty over trade relations, other people said. Corn and soybean futures fell on the news.
Mr Trump has repeatedly complained that China hasn't made the "large quantities" of agricultural purchases that he claims Mr Xi promised when they met in Osaka at the G-20 summit.
Those accusations are "untrue" as Chinese companies have bought US farm products, including soybeans, Mr Cong Liang, Secretary General of the National Development and Reform Commission, said in an interview with China's state broadcaster on Monday, citing purchases agreed to during a trade truce in 2018.
Some deals haven't been completed because the prices are not competitive, he said.
China's commerce ministry didn't respond to a fax seeking comment.
"China is giving up on its softer diplomatic strategy and is no longer willing to be Trump's punching bag," said Mr Chua Hak Bin, an economist at Maybank Kim Eng Research Pte.
"Trump's tariffs threats are backfiring and triggering a full-scale trade war."