Financial markets are intimidated by Trump’s actions. Higher tariffs will be imposed on Chinese imports, adding duties of $34bn a year and China has so far retaliated with similar mark-ups on US imports. On the other hand, the White House has threatened imported cars with tariffs of 20%, which are destined to hit the EU as well. In this setting, the yuan is a victim of the commercial war between the US and China. It has weakened by more than 5% against the dollar in two and a half months, but it is not clear whether the cause is a devaluation of China or the spontaneous market trend. The hour of the dreaded “trade war” between the world’s largest economies is just around the corner.
Beijing On Alert
The yuan has lost 5.3% of its value, against the dollar, since last April and has a negative balance (-1.7%) also compared to the beginning of the year, falling to its weakest level since November. The “off-shore” exchange rate, a little freer than the domestic one, has one dollar being able to buy 6.65 yuan. What is going on? There are two interpretations. The first appears to be the most mischievous, although it should not be discounted: China is reacting to the tariffs of Trump, weakening its exchange rate, in order to offset the expected decline in exports to the US, making national products more competitive. If this narrative is true, President Donald Trump would find confirmation of unfair competition from Beijing with devaluations.
Yuan Weak for Economic Reasons?
However, it seems that the reasons for the thud of the yuan are purely economic. The Asian currency could be weakening on fears of the markets over a slowdown in the Chinese economy, which is likely to result in a “sudden landing”, in the event that the burst of anti-US tariffs and retaliation are resolved. To make matters worse, the People’s Bank of China (PBoC) has lowered the mandatory reserve ratio for large banks from 16% to 15.5%. This step would result in the release of approximately $107bn in loans, increasing outstanding liquidity. Moreover, it seems that in the last sessions – during which the exchange rate against the dollar depreciated by 3% – the PBoC set the daily starting rate at levels slightly stronger than those expected on the basis of market forces alone. This seems a clear sign: the institution would have already tried to contain the weakness of the yuan, not to annoy the America of Trump and to avoid capital outflows as in the summer of 2015, which would end up more than compensate for any benefits deriving from a more favourable exchange. In this context, the Shanghai Stock Exchange has already come to lose 20% of the peaks at the beginning of the year, basically entering a “bear” phase.
Drastic Times Call for Drastic Measures
A less interventionist foreign exchange policy is required to turn the export-led economy into a more internal-demand one. A devaluation would have the effect of favouring capital outflows and pushing up the rates necessary to counteract them, at the expense of consumption and investment. Given this, the Beijing authorities would have many reasons to prefer a strong currency: making the yuan a reference currency for the Asian market first of all.
A devaluation does not significantly favour exports, in the Chinese case especially. According to recent research by the World Bank and the International Monetary Fund, the links between the exchange rate and trade are no longer as strong as before: the elasticity of exports at the exchange rate has decreased over the last fifteen years (on average for a group of 46 countries including China) and 40% of this reduction is due to the participation of countries in international trade through global value chains. With the international fragmentation of production, the amount is risen by the weak exchange rate, which does not have a great effect on exports now. However, it could be objected that reducing the dependence on imports of intermediate technological goods is one of the main objectives of the “Made in China 2025” plan, which aims to increase national added value. From this point of view, a weak exchange rate creates a coherent system of incentives.
A Slap on the Wrist
But, there are many more reasons to prefer a stronger yuan for now and this is why the Chinese central bank is not orchestrating a devaluation. The flight from the Chinese currency, in fact, stems from the growing divergence in interest rate developments in China and the United States as a result of the Fed’s tightening and an invariably expansive monetary policy in Beijing. The uncertain prospects for domestic demand and growth also make equity stocks unattractive, which have lost 14 per cent since the beginning of the year on the Shanghai Composite Index: a warning sign for Chinese companies which are, on average, highly indebted.
In conclusion, it seems that the weakness of the yuan is not by design, but due to the international economic dynamics of recent months. Once the exchange rate of 6.7 has been reached, some analysts believe that China will set in the “anti-cyclical factor”. A “mysterious component”, introduced five years ago, which consists of combating the yuan’s one-way variations against other currencies.
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