Yuan’s Slide Is Gold Standard Moment for China
The decision to let the currency weaken beyond 7 to the dollar echoes previous turning points of historic global significance.
George Magnus
Straits Times, Singapura – 9.8.2019
China allowing the yuan to slide below 7 to the dollar is a watershed moment for currency markets that's symbolically equivalent to the U.S. and other countries abandoning the gold standard in the interwar period, or the collapse of the postwar Bretton Woods system of fixed exchange rates four decades ago. The implications for the global economy are equally significant.
The world’s major currencies aren’t tethered in the way they were in those periods, but gold and Bretton Woods both served as anchors for the world’s monetary system, and their demise reflected the economic and political disarray of their times. Today, the yuan is semi-pegged to the U.S. dollar. The arrangement serves as an anchor for China’s financial system, now the world’s largest by assets; for many currency systems in Asia and around the world; and for U.S.-China economic and financial relations.
If that mainstay ruptures, it’s liable to set off chain reactions inside and outside China. That’s why the loosening in currency policy by the People’s Bank of China this week, while it may seem unremarkable for most people, is an important development.
It may be too early to assert that China is “weaponizing” the yuan in the deepening trade war with the U.S., especially because the central bank’s actions still appear measured and moderate. Nevertheless, the assumption that keeping the yuan rate stable against the dollar was part of the complex politics surrounding the trade negotiations no longer holds. President Donald Trump’s decision to impose a 10% punitive tariff on a further $300 billion of Chinese imports – perhaps a waymark to 25% at a later date – looks to have changed the calculus.
China can no longer engage in tit-for-tat tariffs because it imports so much less than it sells to the U.S. Its only options are to target American companies using its own “ entity list” of firms deemed to damage Chinese interests; make life more difficult for them in China; and ultimately to depreciate the currency. The political decision to sanction the move suggests China has weighed the costs of a weaker currency and decided they are less than those of an impasse in talks and continued economic harm from tariffs.
A cheaper yuan, or renminbi, will help Chinese exporters compete in the U.S. and global markets, offsetting the impact of tariffs to some extent. In the short term, it will help to prop up China’s fragile growth momentum.
The negative implications are more severe, though. A weaker currency will hurt Chinese consumers, who will pay more for imports, and hinder the intended shift in the economy to a more consumer-oriented structure. It will raise the credit risk and vulnerability of Chinese property and other companies that have been borrowing increasing volumes of dollars in the past few years. It will almost certainly encourage residents to try to evade capital controls and place money offshore. This happened in 2015-16 too, though the strengthened capital controls regime since then is likely to be more effective for the time being.
Beyond China, the yuan’s slide is likely to trigger competitive currency depreciations, especially in countries that are part of its Asian supply chains and those that compete with Chinese products. The dollar will be the de facto beneficiary, often a sign that the world economy is faltering. A weaker renminbi will hurt U.S. producers and exporters at a time when the American economy is softening. It will also reduce the foreign earnings of U.S, firms, and as a result, the equity market.
The political significance may be at least as great. The importance of the renminbi, literally the “people’s money,” to China is no less than that of the dollar to America or sterling to the U.K. China’s economic narrative places much pride in, for example, its $3 trillion stock of foreign-currency reserves, and attaches extraordinary status to the role and function of the renminbi. The decision to put the stability of the currency at risk won’t have been taken lightly.
As far as economic activity is concerned, the yuan’s move through 7 almost certainly reflects concern over the weaker trajectory of the economy, in which trade plays a relatively small direct role, though a cumulatively more important one. It’s not only the effect of tariffs that filters through China’s economy, but the loss of productive capacity as a rising number of firms move supply chain operations, and jobs, outside the country. A major Chinese investment bank recently suggested the industrial sector has lost about 5 million jobs in the last year, almost half of which are attributable to the trade war.
The yuan’s move appears to reflect frustration at the lack of progress in trade talks, and specifically the refusal of the U.S. side to remove tariffs as a condition for any Chinese concessions. The depreciation will be managed for the time being, but it’s unlikely to stop. With time, the rapid expansion of financial assets in China, combined with political pressures, will probably lead to a much greater decline.
By then, it won’t be only financial markets that are paying attention. The yuan’s path may help shape the future of geopolitical and economic arrangements around the world. (Bloomberg)
