China has an Achilles' heel in the capital outflows that it has tried so hard to control. Although a weaker U.S. dollar aided China's efforts to stem the flow of cash leaving the country in 2017 and gave a boost to the yuan, things may be about to change.
The Trump administration looks like it's moving closer to labeling China a “strategic competitor,” and a trade war is becoming a real possibility. In addition, further interest-rate hikes by the Federal Reserve, when combined with tax cuts, may cause the dollar to strengthen -- and the yuan to weaken -- as capital flows into the U.S.
There are several ways that China could respond to these three events, but none are likely to result in further upward pressure on the yuan.
In a global economy, a country's tax policy is essentially the cost of doing business and a key indicator of competitiveness. The cut in the U.S. corporate tax rate to 21 percent from 35 percent generated a strong response from Japan, home to the world's third-largest economy, which approved a corporate tax cut with incentives tied to wage increases. Will China, home to the second-largest economy, join the race to cut?