Blog Post

The ‘seven’ ceiling: China’s yuan in trade talks

Investors and the public have been looking at the renminbi with caution after the Trump administration threatened to increase duties on countries that intervene in the markets to devalue/undervalue their currency relative to the dollar. The fear is that China could weaponise its currency following the further increase in tariffs imposed by the United States in early May. What is the likelihood of this happening and what would be the consequences for the existing tensions with the United States, as well as for the global economy?

By: Date: June 3, 2019 Topic: Global Economics & Governance

The renminbi has been depreciating since June and is currently hovering around 7 yuan per US dollar. The current value, the lowest since December last year, raised some eyebrows as it could signal currency manipulation.

Soon enough, trading volumes increased as speculators tested whether the People’s Bank of China’s (PBoC) paid heed to the symbolic ‘7’. But can a weaker yuan really be interpreted as a retaliation to trade tariffs? As John Authers argues, the yuan is “no longer a pure expression of the wishes of Chinese authorities, but still not a pure expression of the will of the market either. A move above 7 yuan would have once been taken as an act of aggression by the Chinese authorities. Now there is also the possibility that it could be taken as a loss of confidence in China or economic weakness.”

For Alicia García-Herrero and Jianwei Xu, although a PBoC intervention in the renminbi market is expected, the ceiling at 7 yuan is not the key concern. Instead, China’s focus is on growth, and the renminbi is “increasingly important” to achieve this, as substantial depreciation could lead to capital outflows and reduced liquidity. “The PBoC has definitely realized that any one-way betting on the CNY could only dampen its efforts to control the currency.” As such, the best and less costly strategy for the PBoC “is to lean with the wind for forex intervention rather than against”, and to “introduce more two-way volatility” as it did in early 2014. In case investors begin speculation and start “betting on the one-way movement of the RMB”, the PBoC will act so as to avoid rapid capital outflows and “do its utmost to make them pay as it did in March 2014”. Authers also recalls the PBoC’s “recent history of catching investors off guard even when it did not mean to”.

Indeed, a weaker yuan could merely be a reflection of the Chinese growth slowdown. Daniel Moss writes for Bloomberg Opinion that the focus should be on the “velocity and timing of exchange-rate moves”, and that “it makes sense for a slower China to have a weaker currency”. Renminbi cracking beyond 7 yuan per US dollar would be a reflection of economic conditions and policy responses. The slowing growth is reflected in exchange-rate conditions, a trend “underway long before President Donald Trump took office”. Mark Sobel, a former senior US Treasury official, also makes this a “case of economic reality rather than ‘weaponisation’” and illustrates it with China’s flat current account and “unsustainably high” growth targets. The shape of the current account could change down the road into a U-shape, points Alicia García-Herrero, who signals tourism as “an obvious source of unrecorded capital outflows” that “may be restricted to push up the current account surplus”.

it makes sense for a slower China to have a weaker currency

Either way, some have stressed the costs of pursuing weaponisation of the yuan. A devaluation strategy would be damaging for central-bank credibility and for the international position of renminbi as a global reserve currency. It would also likely intensify tensions with the United States, as well as lead to capital outflows.

Hao Zhou, senior economist on Commerzbank, writes for the South China Morning Post that strategies such as weakening the yuan or selling off US Treasury notes have no economic reasoning and can be “double-edged swords that could hurt both the US and China”. Rising import prices and a wider trade surplus resulting from a devalued yuan could lead to more retaliatory tariffs from the United States. The PBoC sold forex reserves to defend the yuan, which is already under pressure. Letting it devalue even more would unsettle financial markets and “intensify concerns about the Chinese economy”.

Zhou also dismisses a scenario where China sells off US treasury notes, as these are liquid and offer attractive yields. Furthermore, the purchases with dollars resulting from the sales would “probably lead to dollar depreciation and consequently yuan appreciation – which might be exactly what Trump was hoping for”.

On the other hand, Brad Setser sees a weaker currency to offset the impact of US tariffs as “a logical ‘asymmetric’ response to a trade war”. The assumption, Setser explains, is that China has already established its commitment to exchange-rate and balance-of-payments stability, and can thus allow its currency to weaken with no financial stability harm. In theory, this controlled depreciation could work, in Setser’s opinion, for as long as there is a “signal at some point that once the yuan had reset down, China would resist further depreciation”. By adjusting the yuan’s trading range to the latest US tariffs, Chinese firms could keep their yuan revenues while at the same time cut their dollar prices. This, however, would come at a cost for China and the rest of the world: “in effect, [it] redistributes some of China’s trade pain globally, and thus poses a challenge to those parts of the world that have relied on exports rather than domestic demand to power their own economies”.

In the meantime, the United States Treasury has released their currency report and did not call out China as a currency manipulator. The PBoC has also recently centred its communication around the stability of the yuan rather than the number ‘7’. Still, one should be wary of the fact that foreign exchanges are currently being factored into trade talks, especially when these are evaluated by a national treasury under an idiosyncratic methodology.

Kenneth Rogoff urged that the renminbi be left out of the United States-China trade talks. Imposing a stable renminbi against the dollar could potentially “exacerbate global business cycles or even plant the seeds of the next Asian financial crisis”. The interest-rate parity imposition would be inappropriate, as China’s and the US’ business cycles rarely align; maintaining an inflexible exchange rate would turn out to be a bottleneck when China “comes under serious financial and macroeconomic pressures”. Furthermore, it would prevent other needed economic reforms.


Republishing and referencing

Bruegel considers itself a public good and takes no institutional standpoint. Anyone is free to republish and/or quote this post without prior consent. Please provide a full reference, clearly stating Bruegel and the relevant author as the source, and include a prominent hyperlink to the original post.

View comments
Read article More on this topic

Blog Post

Implications of the Japan – United States Mini Trade Agreement

Details of the US-Japan mini-trade deal are lacking but the agreements’ direct impact on the US and Japanese economies is likely to be minuscule. The deal seems to have been made to compensate American farmers – a crucial electoral base of the President – for their losses from the trade war with China.

By: Sybrand Brekelmans and Uri Dadush Topic: Global Economics & Governance Date: October 11, 2019
Read article More on this topic More by this author

Opinion

The Case for Intelligent Industrial Policy

Although national industrial policies have a bad reputation, there is a strong case for government support to sectors that will increasingly rely on artificial intelligence. In this regard, the German government’s plan to promote production of electric-car batteries may accelerate an industrial renaissance in Europe.

By: Dalia Marin Topic: European Macroeconomics & Governance Date: October 7, 2019
Read article

Opinion

Southbound flows rescuing Hong Kong equity market

China seems to be coming to the rescue as social unrest affects the city’s financial market, but it’s probably only for arbitrage reasons

By: Alicia García-Herrero and Gary Ng Topic: Finance & Financial Regulation, Global Economics & Governance Date: October 2, 2019
Read article More by this author

Blog Post

Questions to the High Representative and Vice-President-designate Josep Borrell

Josep Borrell, the incoming High Representative and Vice-President-designate must explain how von der Leyen’s ‘geopolitical Commission’ intends to adapt to a global landscape dominated by an intensifying rivalry between Washington and Bejing.

By: Jean Pisani-Ferry Topic: European Macroeconomics & Governance, Global Economics & Governance Date: September 30, 2019
Read article More on this topic More by this author

Podcast

Podcast

Deep Focus: What's slowing the Mercosur agreement?

The EU-Mercosur has been 20 years in the making, but a hostile trading environment, unpredictable government and growing environmental concerns are putting it in peril. Is the deal worth fighting for and can it be saved? And could it become a casualty Brazil's forest fires?

By: The Sound of Economics Topic: Global Economics & Governance Date: September 27, 2019
Read article More on this topic More by this author

Blog Post

Questions to Phil Hogan, Commissioner-designate for Trade

At the presentation of her team for the next European Commission, President-elect Ursula von der Leyen declared that hers will be a ‘geopolitical Commission’. It is no surprise, therefore, that her mission letter to Mr Hogan, the incoming Commissioner-designate for Trade, assigns two roles to European Union trade policy. 

By: André Sapir Topic: European Macroeconomics & Governance Date: September 25, 2019
Read article Download PDF

External Publication

European Parliament

Challenges ahead for the European Central Bank: Navigating in the dark?

Since the second half of 2018, signs of a slowdown have been piling up in the euro area. The ECB will face major challenges in this potentially difficult period: its main tools are nearly exhausted, the monetary union in which it operates is still incomplete, and it lacks the understanding of what the ‘new normal’ looks like. The authors, therefore, urge the ECB to review its strategy and framework to be able to face these challenges.

By: Grégory Claeys, Maria Demertzis and Francesco Papadia Topic: European Macroeconomics & Governance, European Parliament, Testimonies Date: September 25, 2019
Read article Download PDF More on this topic

Policy Contribution

The European Union-Mercosur Free Trade Agreement: Prospects and risks

After nearly 20 years of on-off negotiations, the European Union and Mercosur – a customs union covering Argentina, Brazil, Paraguay and Uruguay – in June 2019 reached a political agreement on a trade deal. But to derive the full benefits from the EU-Mercosur agreement, major reforms will be needed.

By: Michael Baltensperger and Uri Dadush Topic: Global Economics & Governance Date: September 24, 2019
Read article

Blog Post

The EU is in the US trade war crosshairs. It should further raise its game

The incoming European Commission faces a dilemma on the transatlantic trade relationship, because of the unpredictable policies of the Trump administration. The EU must rally its citizens; the greater the divides between member states and EU institutions, the lesser the chances are of forging effective policies toward the United States and China.

By: Anabel González and Nicolas Véron Topic: European Macroeconomics & Governance, Global Economics & Governance Date: September 19, 2019
Read article More on this topic

Opinion

Trump's Backfiring Trade Policy

President Trump’s radical trade policy continues, as do trade disputes with China. The president promised to sign far better trade deals, ensure fair treatment of American firms and reduce the United States’ trade deficit. None of these objectives have been met.

By: Uri Dadush and Laurence Kotlikoff Topic: Global Economics & Governance Date: September 17, 2019
Read article Download PDF More on this topic

Working Paper

EU trade policy amid the China-US clash: caught in the crossfire?

What risks face the EU with regard to China’s strategic aims in trade policy and how can the EU respond? The US effort to isolate China poses particular risks for Europe. How can the EU counter such efforts with the aim of forging its own distinct trade policy? How should the EU move forward with reform of the World Trade Organization (WTO) in light of differing demands and aims of trading blocs like China and the US?

By: Anabel González and Nicolas Véron Topic: Global Economics & Governance Date: September 17, 2019
Read article More on this topic

Opinion

China's dual banking system: consolidation as the final solution for weak small banks

There are fundamental solvency and liquidity issues for some small Chinese banks, widely influencing both the bond market as well as the broader financial sector. Given the difficulties in creating a level playing field between small and large banks, there is an expectation that small banks will continue to under-perform.

By: Alicia García-Herrero and Gary Ng Topic: Finance & Financial Regulation Date: September 16, 2019
Load more posts