Should President Donald Trump's administration intervene in global foreign exchange markets to hit back at China in the ongoing trade war between the world's two largest economies?
It's not that simple, according to a new report from Bank of America, the second-biggest U.S. lender.
The Treasury Department earlier this week unexpectedly labeled China as a currency manipulator, kindling speculation that the U.S. government might start selling dollars from its 85-year-old Exchange Stabilization Fund to push down the value of the dollar.
Such a move would bolster U.S. companies' competitiveness in international commerce, while helping to offset any damage from this week's slide in China's currency past 7 per dollar, previously seen by investors as a ceiling for the exchange rate.
But a new report from Bank of America suggested that Trump would face a major obstacle in such an effort: the need to maintain foreign investors' willingness to buy U.S. Treasury bonds, especially with the $22 trillion national debt projected to swell in coming years thanks to annual federal budget deficits approaching $1 trillion.
"It is not clear it is in the best interest of the U.S. to go down this path, especially given the huge budget deficit which the U.S. continues to rely on foreigners to help finance," the Bank of America analysts wrote this week.
The Exchange Stabilization Fund, which can be used for currency interventions, dates back to 1934. Any operations would have to be authorized by Treasury Secretary Steven Mnuchin, who has been a staunch supporter of Trump's since well before the president's surprise victory in the 2016 election.
The fund was tapped in the 1960s and 1970s and was key in the 1985 Plaza Accord, a coordinated effort among developed countries to devalue the U.S. currency.
According to the Treasury's website, the fund hasn't been used for a currency intervention since 2000, when $1.33 billion was sold to target the euro exchange rate.
As of June 30, the fund had $94.6 billion of assets, including U.S. government securities, special drawing rights, euros, euro-denominated securities, Japanese yen and yen-denominated securities.
Trump repeatedly has complained that Chinese officials purposely keep the yuan weak to benefit domestic industry at the expense of U.S. manufacturers. But it wasn't until this week that the Treasury took the step of officially designating the country as a currency manipulator, the first step in a process that could ultimately lead to a decision by the International Monetary Fund.
Officials with China's central bank have said the yuan's slide was due to market forces, likening the move past 7 per dollar to a reservoir that rises and falls when the rainy season comes and goes.
Some forecasters say that explanation makes sense since the Asian economy, the world's second-largest, has been slowing, and despite stiff capital controls some investors are anxious to pull their money out.
But the country is known for its closely managed exchange rate, routinely wading into foreign exchange markets to stabilize the yuan. So the Trump administration essentially accused officials of arbitrarily abandoning their usual practice of heavy intervention.
As of Thursday, the yuan was trading at 7.04 per U.S. dollar, the weakest fixing in more than a decade.
"Currency intervention is primed to become the next front in the trade fight, with options available to the president under executive authority that would seek a realignment of the dollar," Ed Mills, a policy analyst in Washington for the brokerage firm Raymond James, wrote this week in a report.
But according to the Bank of America analysts, a currency intervention by the Treasury Department to weaken the dollar against the yuan might carry long-term consequences -- such as an erosion of the U.S. currency's status as the global reserve currency.
And it's partly due to that esteem that foreign investors, governments and central banks are willing to finance the growing U.S. national debt, even with yields on 10-year U.S. Treasury bonds currently at just 1.77%, close to historic lows.
"Unilateral foreign-exchange interventions would undermine the U.S. dollar's reserve-currency status, which would increase the risk premium investors would demand for holding U.S. assets," wrote the Bank of America analysts, led by David Woo, a strategist covering foreign exchange, interest rates and emerging markets. "It is not clear that the trade-off between a weak dollar and higher borrowing costs would be acceptable to the administration."
For Trump, his options are becoming more complicated.