The Truth About China’s Currency

China Chinese spies currencyThe United States and China are waging a trade war of words, where phrases like “coerced technology transfer” and “25 percent tariff” are tossed around but nothing actually happens. Another mostly empty phrase is “currency devaluation.” China won’t devalue the yuan against the dollar, for reasons which may surprise both policymakers and mainstream economists.

Most pointedly, the last time Beijing devalued, Chinese exports did not soar. Instead, money fled the country. In August 2015, the People’s Bank of China talked vaguely of a new exchange rate regime and tacked on a small devaluation against the dollar. Money was leaving China on a net basis at the time. The pace of capital exit then roughly doubled, because holders of yuan believed it would become less valuable.

Remarkably, the People’s Bank shot itself in the same foot in January 2016. Capital exit was slower this second round but the cumulative effect was enough to trigger global concern about a balance of payments crisis. Lesson finally learned, Beijing toward the end of 2016 imposed new restrictions on money leaving the country and reversed the yuan’s slide against the dollar with a seven-percent rise during 2017. The result was that foreign exchange reserves stabilized. A devaluation risks money leaving again, directly contrary to China’s policy goals.

What policymakers often fail to understand is Chinese currency policy is not a reflection of strength but weakness. Related, what mainstream economists often fail to understand is China’s exchange rate isn’t meant to adjust to change – for example to new US tariffs – it’s meant to enforce stability.

Capital exit isn’t a problem Beijing solved in late 2016, it’s chronic. From infrastructure bonds to fight the Asian financial crisis to government funds directed to semiconductor firms today, China relies on extraordinary savings by its people to fund state initiatives. Savings are trapped in low-interest accounts at state banks, long known as financial repression.

China claims to have a fast-growing economy but the strain on its financial system is growing much faster – from 2009 through 2016, credit extended to the non-financial sector rose at more than twice the pace of reported gross domestic product. The United States took 34 years to add to its debt burden what China did in eight (the Trump administration seems to see this as a challenge).

The starting point of Beijing’s financial policy is to ensure ordinary Chinese keep handing their money to domestic financial institutions, to keep the credit machine churning. Tools used are the restrictions on money leaving the country and an exchange rate which is set, first and foremost, to keep people from wanting to test those restrictions.

So the primary goal of Beijing’s exchange rate policy is not to boost exports, as US critics believe. It’s not to adjust to domestic economic shifts, as basic economics indicates. It is impossible to identify the yuan’s “true market value”, and hence undervaluation or overvaluation. China has a non-market financial system. It is a non-market system that dictates the yuan’s level and movement.

The International Monetary Fund treating the yuan as if it’s equivalent to the euro or the yen thus has no financial justification, it’s purely political. Meanwhile, those calling China a currency manipulator are correct, but not the way they think. China manipulates the yuan by largely pinning it to the dollar: It has stayed between 6 and 7 to the dollar for the last decade. Beijing does this mostly looking inward for the sake of stability, not outward for growth.

That last closes the circle on devaluation talk. A China devaluation threat stems from the idea it would cost American jobs. But such fear is misguided. In January 1994, China devalued the yuan a staggering 50 percent and the American job market soared. From mid-2005 to mid-2008, the yuan rose 18 percent against the dollar and our job market weakened.

The main reason for this is China’s currency does not matter compared to our own policies. The second reason is China’s currency does not work the way normal currencies work. For both reasons, there won’t be a devaluation. There’s little reason to believe it would hurt the United States and plenty of reason to believe it will hurt China.

From - AEI.org - by Derek Scissors

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Dolores Aams
3 years ago

As far as I’m concerned you can’t trust the Chinese.

3 years ago

Obama once said there is no difference between public debt and private debt. That is either an ignorant misconception or sinister deception. When the Euro was devalued, the argument was that the dollar would have to be devalued, or else European consumers would find American products to be too expensive. It doesn’t take into consideration that after devaluing the Euro (floating more debt), Europeans now have more Euros to spend, and the cost of goods in Europe goes up for all goods, not just for Americans goods. So if you [the government and their insiders] know when you are going to devalue the currency, you can profit by money changing between currencies – use dollars to buy a stable currency, and then devalue the dollar, and then buy dollars back. You get a windfall profit. Who pays? The American consumers who use devalued dollars when they see the inflation it causes. It also HURTS American businesses that are selling products abroad, since the real production cost of the goods was before the dollar was devalued. Now businesses have to raise the price of the goods they’re selling. So how did that help anyone but the money changers? Hopefully Trump has a much better business sense than his predecessors. Like Schwarzeneggar (who took $0 pay) did with state workers in California, Trump should cut the wages of all Federal workers. There has to be a mechanism that allows the Federal Governement to shrink when the economy shrinks.

Ivan Berry
3 years ago
Reply to  Hank

Hank, simple truths are sometimes too simple for simple minds to comprehend. Perfect definition of inflation, the cause, and not the efect.

3 years ago

China is currently expanding its presence throughout Africa and South America by buying up the critical natural resources of various countries that will allow China to expand its power over the next 30 to 50 years. All at attractive rates, while also establishing permanent Chinese footholds in all these countries. They are also buying influence in all these countries by promising the leaders of these countries both political stability and massive infrastructure projects. Both of which China then lends these countries the money for. Hardly the type of geopolitical and economic climate where China would be even remotely be considering devaluation of their currency. No one seriously believes that China is either considering or even will have a need to devalue their currency at this point.

As for the comparison between China and the United States. They are really pursuing two different strategies. China is the world’s largest creditor nation at this point. Essentially bankrolling countries around the world and buying up strategic resources and expanding their influence. Their trillions in cash reserves are the result of all those lopsided trade deals over the last 25 years that President Trump keeps talking about, but everyone in the MSM and the Democrats say really don’t matter. The United States is the largest debtor nation in the world thanks to Washington’s inability to curtail runaway spending and massive government waste. We borrow about 50 cents of every dollar the government spends every single day of the year. That’s our $21 trillion dollar national debt that is ballooning every day. Essentially we are living off credit cards and hoping the bank (China, India, Japan, etc.) keeps extending us more credit forever as we find new ways to waste each dollar. Even as the re-payment balance keeps rising higher and higher.

Think of it this way. You have two uncles. One who has bank vaults filled with cash and can afford to buy anything. That’s China today thanks to us and other western nations being incredibly stupid in trade deals and assumptions that China really wants to be just like us. The other uncle lives off a string of credit cards, which are to a large part are kept active from loans from the first uncle. That’s the United States government today. So when you talk of the need to devalue one’s currency, which one of these two uncles fits that model? Hint, it isn’t the first one who has bank vaults filled with cash and isn’t carrying a huge debt load.

Ivan Berry
3 years ago
Reply to  PaulE

Not only is China buying up resources world wide, they are cutting deals as with Russia to eliminate petro dollars as the world’s exchange medium to further remove the dollars’ influence, giving the yuan greater favor, all while continuing to increase their gold holdings.

So far as manipulating currency goes, the U.S. uses QE this and QE that to increase the money supply in order to stimulate business expansion, resulting in loss of per dollar value, while creating bubbles and mal-investment.
The U.S. now must go to other countries for many strategic materials. China wisely is in the process of acquiring those as we regulate ourselves out of producing our own.
As has been stated before, China promotes on merit. Only smart people rise in the ranks of leadership. The U.S. no longer operates on a meritorous principle, therefore we can and do have some really dumb leaders. Extreme diversity has its limits: limits growth, limits innovation, limits critical reasoning, liberty and independence.

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