The People’s Bank of China may be in the process of losing its collective mind. Again. In August 2015 and January 2016, China’s central bank changed currency policy in opaque fashion. The result was intense capital outflow and ultimately a policy reversal. It may be happening again; if so, the results this time would be worse.
The yuan has been slipping against the dollar since the beginning of May. From that time until election day, it fell from 6.47 to 6.8. The decline has accelerated since Donald Trump’s election as President and the yuan yesterday touched 6.9, an eight-year low. The reason for this is said to be theglobal strength of the dollar.
The dollar has been strong. The question is: why isn’t the RMB at least as strong? China has run the biggest trade surplus in the world for a decade, its benchmark real interest rate is higher than America’s benchmark, China claims it’s still growing considerably faster than the US, and that its financial system is sound, with very low levels of bad debt.
At base, there are two competing explanations for RMB weakness, both disturbing. One is that the Communist Party not only exaggerates the strength of the economy, but wildly exaggerates. The Chinese economy is in truth considerably weaker than the American economy and the value of the yuan reflects that. Chinese people sending huge sums overseas matches this view.
Here, the failure of the People’s Bank lies in monetary policies that helped create this mess. The biggest problem is accommodating continued massive borrowing by state entities, which has pushed up debt at a pace perhaps unmatched in world history. In comparison, allowing the yuan to drop another 15% against the dollar will accomplish almost nothing, other than upset the US.
That raises the second possibility – the Chinese economy is in fact performing adequately for the moment and the yuan’s drop reflects the People’s Bank deliberately weakening the bilateral exchange rate. China could be seeking some sort of trade advantage or it could be hoping to preemptively change the conditions facing the new US administration.
This is the crazy part. Global trade is weak and US-China trade is shrinking. But China’s 2016 goods trade surplus with the US will surpass $300 billion, again. That’s $300 billion annually of foreign exchange at risk. If the US refuses to accept continuation of the trade surplus – referred to by the President-elect as “losing”– strains from capital outflow will give way to a full-blown balance of payments crisis for Beijing.
Perhaps Xi Jinping and company anticipate difficult negotiations with the US next year and believe a weaker exchange rate now will help with bargaining later. While that’s possible, it’s more likely the sliding yuan will only strengthen those Trump advisers calling for immediate economic action against China. Beijing will have started the trade conflict it keeps warning against.
Whatever the motivation, the People’s Bank is again being less than forthright. Platitudes about “no basis for the yuan to depreciate” clash with 13 days of setting parity against the dollar lower. The last two episodes of opaque exchange rate intervention harmed China’s financial position and, with President Trump inbound, a third swing and miss would be the worst yet.