China's Currency Policy Approaches Breaking Point
FEB 7, 2017 8:00 PM EST
By Junheng Li
In his first few weeks in office, President Donald Trump has ordered the U.S. to withdraw from the Trans-Pacific Partnership and confirmed his intention to renegotiate the North American Free Trade Agreement. The consensus is that it won’t be long before he turns his focus to China, which he calls a currency manipulator.
China can weather such criticism, for now. But if Trump’s threats of trade sanctions and 45 percent tariffs become real, the economic impact for the world's second-biggest economy would be meaningful and could upend financial markets, potentially leading to a global recession. With economic growth already slowing and capital fleeing the nation, China's $11 trillion economy is operating from a position of weakness.
Here’s how it plays out: As the world’s dominant reserve currency, the dollar has no peer. International Monetary Fund data show that the greenback accounts for 63.3 percent of global foreign-exchange reserves, with the euro next at 20.3 percent, followed by the British pound and Japanese yen, both at 4.5 percent. That means that in times of crisis, the dollar benefits from global investors seeking a haven, even if the strife and the the uncertainty emanates from the U.S.
It’s possible that a trade war would drive flows into the dollar, putting upward pressure on the currency at the expense of other exchange rates. That would be on top of the natural demand for the greenback created by the anticipation of significant fiscal stimulus floated by the Trump administration and a faster pace of interest-rate increases by the Federal Reserve.
In terms of China, it’s important to remember that the yuan’s external value is managed by authorities in a way that isn’t compatible with a sharp appreciation pressure of the dollar vis-à-vis all other currencies. The currency is managed to achieve a stable, effective, trade-weighted exchange rate and to foster a gently crawling peg relative to the dollar. That peg would be threatened if a trade war weakened China’s economy at a faster rate than forecast. What was presented as a gradual depreciation of the yuan last year was in reality a significant 6 percent weakening of the currency versus the dollar as China’s domestic woes mounted. A collapse of the crawling peg could lead to yuan depreciation that is three times as large.
Although the pace of depletion of China’s foreign-exchange reserves has eased from $100 billion per month in late 2015, the leakage shows no signs of abating. The $3 trillion official figure for China’s reserves probably overstates the amount of dollars actually available for intervention to support the yuan by at least $1 trillion, possibly more. At least $500 billion of reserves are “encumbered” by forward sales of dollars by the Chinese authorities, which they will actually have to deliver in the future.
The IMF estimates that China needs at least $2.6 trillion of “working capital” to allow companies and the government to conduct import/export operations. The “working capital” is unlikely to be available to defend the yuan because that money has to be held “in reserve” as a fiscal backstop if systemically important Chinese firms with dollar exposure are threatened with insolvency.
Although China may be nearing the point where a significant devaluation of the currency would make sense, there are obvious reasons that the authorities would want to avoid a sharp weakening of the yuan anytime soon. First, the domestic political cost of a collapse of the currency in the year leading up to the 19th Party Congress would be significant. Second, a sharp bilateral weakening would provide the Trump administration with the ammunition to declare China to be a “currency manipulator” and impose trade or investment-related sanctions. The authorities will do everything they can to avoid a hard yuan landing before the party congress.
It’s clear that China’s current currency policy is unsustainable. It can, of course, last longer than anyone anticipates, and then abruptly end. That’s the likely fate awaiting the crawling peg.
https://www.bloomberg.com/view/articles/2017-02-08/china-s-currency-policy-approaches-breaking-point
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comments on article:
Dcoronata • 16 hours ago
disq.us
Okay, just a quick examination... China's GDP for 2015 in total Yuan was 68.9052T. When adjusted for inflation in fixed Yuan (2010) that was adjusted to 60.3212T ($9.3117T).
GDP for 2016 was 74.4127T Yuan, don't quite know what that is in 2010 Yuan but if they claim 6.8% that means inflation would be about 1.1%.
So adjusting for this we get Chinese GDP (2010 Yuan) of 64.223. Convert that to dollars (6.959 on 1/3/2017) and we come to the startling conclusion that relative to the US dollar, China's GDP fell by a small amount, 54 billion dollars to $9.2575.
US GDP (fixed 2009 dollars) went from $16.397T to $16.660T an increase of 263 billion, 2009 dollars.
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Stop Intervening • a day ago
As usual...more fake news
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David Stop Intervening • 17 hours ago
Are you a pro-China whiner or a pro-Trump whiner?
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Dcoronata David • 17 hours ago
Does it make a difference?
Both seem to have the same at heart, even if they don't get Melindadsheehan Stop Intervening • 20 hours ago
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that.
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historyspeaks2016 • 12 hours ago
China is running with a full head of steam to make sure the AIIB takes as much business away from the IMF as possible in their region and around the world.
China's only worry is how many Europeans and Americans are working so that more people can afford to buy more junk/stuff from Chinese factories and keep their own people working.
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SailingNewYorkCity • 17 hours ago
If we're smart we can use this to our advantage. China knows their weaknesses, and we should threaten them with the loss of their most favored nation status unless they stop bullying their neighbors. We can also nationalize their treasuries as payment for enforcement of international law. Let's see if they change their tune then.
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Joseph Siew • a day ago
Yawn.....
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Dcoronata Joseph Siew • 17 hours ago
This does make for interesting economic analysis. For example, the US GDP grew by more dollars in 2014 and 2015 than the Chinese GDP. I'll have to get the data for China when they release their final 2016 but it might be the case for 2016 as well.
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Joseph Siew Dcoronata • 16 hours ago
China 2014 $0.875T. 2015 $0.525T
USA 2014 $0.37T. 2015 $0.415T
But there's nothing proud about the figures. What's more important is whether China could contribute to the happiness of the world population. Currently, people from around the world, with the exception of China, Russia, the Philippines, etc., are unhappy with their governments. The western world decided they need extremists to lead them. I'm afraid with novices running the country, they would fall further behind and continue to blame the "enemies ", and eventually the hatred would become military conflicts.
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Dcoronata Joseph Siew • 16 hours ago
See analysis above- you aren't using exchange rates prevalent at the time.
In dollars comparing 1/2/2016 and 1/3/2017 rates, China's GDP actually fell.
Of course the Chinese people love their government- or else...
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Joseph Siew Dcoronata • 16 hours ago
The figures are all in USD....exchange rates prevalent at that time are taken into consideration.
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Dcoronata Joseph Siew • 16 hours ago
Again see my analysis above. Please note that a Yuan in 1/1/2014 compared to the US$ would be worth $0.8694 on 1/3/2017. That makes a huge difference.
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Joseph Siew Dcoronata • 5 hours ago
I respect that, but wouldn't it be more fruitful if you use PPP?
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