China’s management of its currency, the yuan, is under fresh scrutiny after recent weakening brought it back into focus in the U.S.-China trade war. The yuan slid closer to 7 to the dollar, a line it hasn’t crossed in more than 10 years, just as the two sides again ratcheted up tariffs with threats of more to come. Chinese officials say they favor a stable currency, and economists say some weakness in the currency is justified. But since a weaker exchange rate makes Chinese goods cheaper, there’s at least some risk the trade war will spiral into a currency war. U.S. Treasury Secretary Steven Mnuchin at one point stoked expectations for the “strongest ever” currency agreement to avoid competitive devaluations, even as Chinese officials talked about the need to respect their autonomy.

1. How is value of the yuan set?

The Chinese currency doesn’t float freely but is instead managed using a fairly opaque system in which the central bank fixes daily reference rates. Starting in June 2018, when the U.S.-China trade war began to heat up, the yuan went on a record slide that took it to its lowest level in more than a year against the dollar. On Aug. 3 the PBOC made it more expensive for local traders to bet against the yuan, a surprise move that analysts said demonstrated the depreciation had gone far enough for the central bank. On May 20, 2019, the PBOC set the daily reference rate at a level stronger than analysts and traders projected, a sign that Beijing was seeking to slow depreciation again.

2. What’s affecting it now?

It strengthened somewhat in early 2019 after U.S. President Donald Trump called a truce on new tariffs, but began to slide again after the truce collapsed in May. Souring market sentiment was cited by analysts, as China’s economy slows and the U.S. ramps up tariffs. But the decline towards 7 against the dollar also hands potential ammunition to trade hawks in Washington. Warning that the escalating trade war could destabilize the global economy, China’s central bank has vowed to continue with targeted stimulus and keep the currency steady.

4. What does a weaker yuan mean?

It would cushion the blow to China of U.S. tariffs by making Chinese goods more competitive relative to the dollar. But it comes at a cost. A weaker currency risks pressuring households and companies to get money out of the country and would force the government to draw on its reserves -- the world’s biggest at more than $3 trillion -- to defend it. In 2015 the PBOC triggered an abrupt devaluation that spooked global markets and triggered panicky capital outflows. The country burned through about $1 trillion of reserves to stem that exodus.

--With assistance from Will Davies and Tian Chen.

To contact the reporter on this story: Enda Curran in Hong Kong at ecurran8@bloomberg.net

To contact the editors responsible for this story: Malcolm Scott at mscott23@bloomberg.net, Paul Geitner, Jeffrey Black

©2019 Bloomberg L.P.