Trump's trade war with China just took a nasty turn, plunging global markets into chaos as the risk of a second global financial crisis increased "dangerously".

The US President crowed back in March 2018 that trade wars were "easy to win". But here we are, past the halfway mark of his presidency, and this trade war just keeps getting messier and messier.

Photo / Supplied via Twitter
Photo / Supplied via Twitter

The latest development has to do with the value of the Chinese currency. Trump has always been concerned the exchange rate of the Chinese yuan was too low, causing America to be flooded with cheap Chinese goods, news.com.au reports.

Overnight China made its currency even cheaper. That means one US dollar can buy more and more yuan. A US dollar used to buy 6.87 Chinese yuan, now it can buy over 7.

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A MASTER MANIPULATOR?

Unlike Australia, where we "floated" the dollar, China controls the value of its currency directly, by buying and selling in global markets.

The exchange rate of a currency is just its price. When many people want a currency, they bid to buy it and its price goes up. When people don't want a currency, they sell it and the exchange rate falls.

China has long been buying and selling to control the value of its currency on global markets. Trump is sure they are keeping it artificially low, by selling Chinese yuan, but there are some question marks over whether more recently China has been doing the opposite — keeping it high by buying yuan.

Despite this uncertainty, the US has accused China of misdeeds.

"In recent days, China has taken concrete steps to devalue its currency," the US Treasury said in a press release, alleging the intent was "to gain an unfair competitive advantage in international trade".

The quick change in the price of the yuan led to a swift rebuke from the US. It used a formal process to label China as a "currency manipulator".

Under the rules, now China has had this label stuck to it, the US can seek redress through the International Monetary Fund. It's unclear if that will yield anything, but that's what sent global markets into a tail spin.

Stocks tanked on worries that President Donald Trump's worsening trade war will threaten a global recession and drag profits for companies even lower. Photo / AP
Stocks tanked on worries that President Donald Trump's worsening trade war will threaten a global recession and drag profits for companies even lower. Photo / AP

The US stock market had its biggest fall all year, with the Dow Jones index down a whopping 3 per cent in just one day. Australian markets have followed suit today, with the ASX200 falling 2.5 per cent.

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The Australian dollar also tumbled, falling as low as US67.5 cents. Those glory days of Australian dollar parity with the US dollar? They look very long gone indeed. A holiday in the US will cost more than it has for years. You have to go back to the early 2000s to find an extended period where the Australian dollar was this low.

(Ironically those days of parity were caused by a US monetary policy called quantitative easing that caused the value of the US dollar to fall — not totally dissimilar to the currency manipulation that the US now accuses China of!)

Markets have all gone pear-shaped because they worry this new intensity in the trade war will harm global economic growth. Former US Treasury Secretary Lawrence Summers called the situation the most dangerous since the GFC, and started talking about the risk of recession.

So how does Trump get out of this? Maybe by getting out of the White House. The man who wrote the Art of the Deal (or at least had it ghostwritten for him) doesn't seem to be able to finish the fight he started. It is possible Chinese President Xi Jinping, who never faces a real election and recently made himself president-for-life, will try to wait for whomever the next President is before agreeing to terms.

The US will choose a new president in one year and three months' time. China might hope for someone less enamoured with brinkmanship.

THE MERITS OF THE LOW ROAD

Most countries that manipulate their currencies, such as Argentina and Venezuela, try to keep them high, so that it is cheaper for them to buy imports from the rich world. That is risky because it depends on using up US dollars to buy back your own currency at an artificially inflated price. History is full of countries running out of US dollars and seeing their currency collapse.

What China is accused of doing — keeping its currency low to make exporting easier — would be more sustainable, because it involves selling Chinese money on currency markets, not buying it. However, it is unclear whether China has been buying or selling yuan recently.

The most recent formal US report on Chinese currency manipulation — from May this year — found no evidence of Chinese intervention.

"Based on Treasury estimates, direct intervention in foreign exchange markets by the People's Bank of China over the last several months appears limited," the report said, declining to label China as a currency manipulator.

But that all changed today.

Technically, it may be the case that China was manipulating the value of its currency earlier and what made it fall is that they stopped manipulating. But that is by the by. Trump promised during his campaign to designate China as a currency manipulator, and now he has.

So the trade war goes on. China has already chosen to retaliate by not buying US farm products. The question is how bad the economic casualties will have to get before the two sides call a truce.