Chief economist update: Look out below

"If your opponent is temperamental, seek to irritate him."
- Sun Tzu, The Art of War

China's just implemented one of its greatest son's prescriptions and, for sure and for certain, it's gonna irritate Trump.

Financial markets were shell-shocked after the People's Bank of China (PBOC) allowed the yuan to fall below the psychological threshold of CNY7.0 per US dollar.

The official CNY/US$ exchange rate dropped by 1.3% to an 11-year low of CNY7.04 while the offshore CNY/US$ rate fell by 1.8% to CNY7.10 - the first time since it started trading in 2010.

In its statement, the PBOC cited "unilateralism, protectionist trade measures, and expectations of tariffs against China" as influencing factors for the currency's depreciation (code for "take that, Trump").

China could sugarcoat its latest move all it wants, but at the end of the day, it is what it is - retaliation for Trump's latest announcement of the imposition of a 10% tariff on the remaining US$300 billion worth of Chinese imports not yet covered by the trade war.

No more Mister Nice Guy! It appears that Trump has pushed China back so hard against the wall that it's now upping the ante. The yuan's depreciation comes on top of the Chinese government's move to suspend imports of US agricultural products and threats to retroactively impose tariffs on US farm produce purchased after August 3 this year.

China's response shouldn't come as a surprise for it is a natural progression to the escalating war on trade. What is surprising is that it has taken all this time for China to allow market forces to restore equilibrium in its economy.

Note that, the powers that be in Beijing have controlled the currency's exchange rate for fear of being officially branded by America as a "currency manipulator" and/or capital outflows that could lead to increased selling pressure on the yuan.

But as we learned in Economics 101, China's deteriorating economic fundamentals make the yuan's depreciation an imperative (if it were allowed to float freely sans PBOC intervention).

However, digressing from the why's and wherefores of the yuan's depreciation, financial markets have every right to be concerned over the yuan's weakness.

A lower yuan would boost Chinese exporters' competitiveness but it would also stifle exports that compete with Beijing that, in turn, would lead into a price/currency war.

In addition, cheaper Chines exports mean that the Middle Kingdom would once again be exporting deflationary pressure into the global economy. Sure, it was welcomed back in the late-1990's to mid-2000's when global economic activity was going gang-busters.

But not now, not now when most major central banks around the planet are struggling to get inflation up to within their stated target rates - and this time, there's limited scope for monetary policy stimulation with the currently prevailing low, zero, and even negative interest rates.

What's more chilling is that the US-China trade war has now sparked a mini-trade war between Japan and South Korea - both countries removing each other from their respective trade "white list" (preferred list of exporters).

Yes Virginia, Trump has managed to turn close neighbours against each other.

Trump must have read General George Patton's words: "The object of war is not to die for your country but to make the other bastard die for his."

But in this war, the bastard is us all!

Read more: USChinesPBOCBeijingBank of ChinaMr. TrumpAmericaEconomicsGeneral George PattonJapanMiddle KingdomMister Nice GuyPeopleSouth KoreaSun TzuYes Virginia
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