The Falling Yuan: A Wilson Center Panel

For the past few decades, China’s monetary policy has been a consistent thorn in the side of American politicians and policymakers. Critics argued that China kept its currency, the yuan or renminbi, artificially low in order to boost its domestic groups’ ability to export. A weak yuan made for cheaper exports, which led to sustained growth in Chinese industry. In the 1990’s and early 2000’s, Congress had threatened tariffs if the renminbi didn’t rise quickly enough. In 2005, however, Beijing decided to float the currency, though still with some controls. The result was a gentle depreciation in the yuan against the dollar.

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In 2015, the IMF determined that the renminbi was no longer undervalued, despite its depreciation against the dollar in the same period. Today, China watchers are beginning to worry about the falling stocks of foreign reserves at Beijing’s disposal, due to a net outflow of capital and falling GDP growth. These trends ultimately spell a change in Chinese currency policy, but as to when it will be enacted is anyone’s guess.

With this background, the tendency of the new President-elect to be openly aggressive towards China becomes increasingly worrisome. Donald Trump has included labeling China a currency manipulator in his plans for his first 100 days in office, a largely symbolic move that could still inflame tensions. This antagonism towards China over their currency policy is further exacerbated by his recent acceptance of a call from the President of Taiwan, breaking with thirty years of diplomatic precedent and further straining relations with China.

In the context of a belligerent incoming Commander-in-Chief and developments in China’s currency markets, the Wilson Center convened a panel to discuss the situation. Moderated by Dinny McMahon, Fellow at the Kissinger Institute on China and the United States, the panel drew on the expertise of Charlene Chu and Brad Setser. Ms. Chu is a partner at Autonomous Research and previously worked as the Senior Director of the Financial Institutions Group at Fitch Ratings in Beijing. Brad Setser is a senior fellow and acting director of the Maurice R. Greenberg Center for Geoeconomics at the Council on Foreign Relations and previously worked in the U.S. Treasury.

An opening salvo focused on the relationship between the US dollar and the yuan. Ms. Chu discussed the failure of the growth model of the Chinese government. With the ability to keep stable exchange rates dependent on a net inflow of foreign currency, the current reality of a net capital outflows coupled with a decrease in GDP growth from a high of around 15% in 2007 to the current forecast of 6.7% has put an expiration date on the current Chinese currency policy. At this point, with China’s increasing move up the quality chain in terms of produced goods, a depressed currency is also not as valuable as it once was to Chinese manufacturers. With this in mind, it appears that China will ultimately need to decide at what point it is no longer willing to be depleting its foreign currency reserves to perpetuate a stable exchange rate, something that will ultimately become indefensible.

The elephant in the room, of course, is Donald Trump and his attitude towards China. With the question of labelling China a “currency manipulator” on the table, both Mr. Setser and Ms. Chu pointed out that such a label has no immediate consequences. While Mr. Setser pointed out that “currency manipulator” is legally definable through the 1998 Trade Act and the 2015 Trade Enforcement Act, there are no laws on the books in the United States that would require tariffs or punitive measures to be taken against Beijing, were it to be branded as such. More to the point, the case to saddle China with this label is weaker now than it has been at any point in the past fifteen years. If Trump were to undertake such a policy in his first 100 days in office, the largest outcome would be the general political fallout from aggravating China, something that the President-elect appears to relish.

The topic of China’s Foreign Currency Reserves also featured heavily in the discussion. China’s impressive reserves of foreign money come from its policy of buying excess US dollars and other foreign denominations in order to keep the yuan stable vis a vis other currencies. These reserves cause jitters because China invests much of them in US Treasury bonds, which could potentially be weaponized through a massive selloff, were Beijing to decide to take retaliatory action against some American policy. There is some evidence that China has also used its currency reserves to recapitalize state banks, kickstart the Asian Infrastructure Investment Bank (AIIB) and to fund some elements of the One Belt, One Road initiative.

Finally came the topic of the internationalization of the renminbi, one of China’s long term goals. This year, the yuan was added to the IMF’s Special Drawing Rights basket, an elite, if largely symbolic group of national currencies. After being rejected from the group in 2010, Beijing took steps to bring its currency up to snuff, allowing it to float more freely with the market and opening up the bond market overseas. Being included in the SDR basket will ultimately do little for the yuan, in and of itself, but its inclusion is a symbolic step towards the internationalization of the currency. In order to become a true global reserve currency, serious overhauls need to be made in the management of the renminbi and perceptions of stability in the Chinese currency market. To do so will run counter to the instincts of bureaucrats in Beijing, whose first impulse is to manage the yuan in order to promote stability. Doing so is directly at odds with the action they must undertake in order to become a global reserve currency, so it may be many years before such a goal ever comes to fruition.

Photo Credit: Bloomberg News

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