When the US Treasury Department branded China a currency manipulator last year the declaration was made in the absence of any evidence. Sometime in the next 12 months, if not sooner, that evidence might emerge.
In recent years China’s central bank has generally only intervened in the market for its currency to support its value and head off any accusations it was manipulating the value of the yuan to boost the competitiveness of its exports.
It has generally been successful in keeping the value of the yuan below the 7:1 relationship with the US dollar that would trigger a US reaction. So, to the extent that it has “manipulated” its currency, it has been to make it stronger, not weaker.
The pressure on the People’s Bank of China to adopt a different approach and intervene to force the value of the yuan down against China’s key trading partners is mounting. A surge in the value of the currency in the past six months is eroding the competitiveness of China’s economy, threatening to make it a victim of its own successes.
When the threat posed by the coronavirus became evident earlier this year, with China its epicentre, the yuan depreciated about 3 per cent against the US dollar. Since May, however, it has climbed about 9.5 per cent against the dollar and about 4 per cent against the basket of its major trading partners.
That appreciation shows no signs of abating, even though China’s authorities have started to tinker at the edges with measures that appear designed to take some of the heat out of demand for the currency.
The explanation for the sharp appreciation is obvious. China dealt with the initial outbreak of the pandemic, effected a major infrastructure-led stimulus program and has been powering out of its economic slump faster and harder than any other major economy.
Indeed, the US and Europe are still being overwhelmed by the pandemic, with new lockdowns and other economy-damaging measures. In the US the virus is essentially being allowed to run unchecked, fiscal support has been shrivelling and all hope appears to rest on a successful rollout of the vaccines.
The lockdowns have had a perverse effect on global consumer demand that has generated a surge in China’s exports and record monthly trade surpluses that should, along with the domestic stimulus program, enable the country to end this year as the only major economy to have grown in 2020.
The relative economic health of China isn’t the only reason the yuan has been appreciating.
China, when it entered the pandemic, was trying to orchestrate a deleveraging of its over-leveraged economy and financial system, the legacies of the massive stimulus programs implemented in response to the financial crisis more than a decade ago.
It had to put that plan on hold and unleash a new wave of stimulus, albeit a more measured and targeted one, when the pandemic erupted. Unlike the rest of the world, however, where central banks have pushed interest rates close to, or below, zero the PBOC – mindful of those excessive levels of leverage – has left China’s rates relatively unchanged.
A Chinese government 10-year bond yields about 3.3 per cent. The equivalent bond in the US yields 0.89 per cent. In Germany investors pay the government 0.62 per cent for the privilege of keeping their money safe; in Japan the rate is zero and in Australia 0.96 per cent.
With the magnitude of the yield differentials, and fixed income investors desperate for yield, it isn’t surprising that capital has flooded into the Chinese bond market. Those capital flows have also been aided by the inclusion of Chinese government bonds in some of the international bond indices.
Foreign capital has also flowed into China’s stock market, which is up about 27 per cent since March.
Overall overseas fund holdings of China’s bond and stocks have increased by more than 30 per cent this year, according to Bloomberg, so it isn’t surprising that the yuan is at two-year highs.
That yuan strength is threatening to choke off China’s exports’ growth. While President Xi Jinping has recently been touting a new “dual circulation” economic strategy – boosting domestic consumption to reduce the country’s traditional reliance on exports – exports are still the key driver of its growth.
The appreciation of the yuan also comes as (thanks to its sanctions on Australian products and the impact of the pandemic and weather on the Brazilian iron ore industry) the cost of the vital inputs into China’s key steel industry – iron ore and coal – have been soaring and adding to the threats to its growth rate.
Some modest measures have been taken to arrest the appreciation. China has reduced the cost for traders wanting to bet against the yuan and has eased its restrictions on capital outflows.
Unless it reduces its interest rates, however – which would risk a re-leveraging of an already overly-leveraged economy – they will continue to attract the capital inflows that are driving the currency higher and carry with them the threat of another source of ignition for destabilising speculative bubbles.
The broadening range of US sanctions on Chinese individuals and companies – international index managers are scrambling to remove sanctioned companies from their indices – the Trump administration’s ban on its federal public servants’ pension fund investing in China’s securities and a sudden wave of defaults by state-owned or backed companies on their bonds may all ”help” at the margin but are unlikely to put much of a dent in those inflows.
The other option, of course, is direct intervention by the PBOC to try to keep a ceiling on the currency – currency “manipulation” or, as a last resort, capital controls.
While that might produce hostile reactions elsewhere (even though almost all the major central banks, including the Reserve Bank, are using monetary policy to try to weaken their currencies and make their exports more competitive) there are few available sanctions for currency manipulation. It’s not as though the threat of more US tariffs will intimidate the Chinese leadership.
China’s best hope – and Australia’s, given that the Australian dollar has been dragged relentlessly higher because of its exposures to China’s economy – is that the rollout of the vaccines around the world bring the pandemic under control and growth rates, and subsequently expectations of higher interest rates, pick up strongly elsewhere.
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Source: Thanks smh.com