The Chinese currency has just lost, in less than a month, almost 4% of its value against the dollar and the euro. In a context of high tension between the Unites States and their trade partners, atop of them is China, nothing more was needed to reach to the conclusion that in order to respond to the protectionist policy of the American president, a currency war will be added to the trade war which is threatening. The new governor of the Chinese central bank, Yi Gang, who has succeeded in March to Zhou Xiaochuan, who had chaired the institution for 18 years and who has been the architect of the internationalization of the Yuan, immediately intervened to say that “the exchange rate of the Chinese currency will remain basically stable at a reasonable and stable level.”
We will see in the coming days if he has convinced financial markets. Chinese authorities attribute this tension rebound to a cyclical phenomenon which generates a rise of the dollar and the fall of emerging countries currencies. But the downturn of the Yuan against the euro which does not take advantage of the same situation has been as deep as against the dollar. Growth in Europe is running out of steam and tensions between governments are rising. So the ECB has confirmed during its June meeting that it will continue its accommodative policy at least until the end of the year. 10 years bonds carry very low interest rates both in Germany (0.30%) and in France (0.6%) but to the difference of past years, inflation is now near 2%, mainly due to energy prices rise.
These last years, the Chinese currency has been much less stable than authorities are claiming. Against the dollar, between June 2015 and June 2017, it has experienced a downturn period, falling from 6.20 to 6.75.Then it rebounded and in one year it recovered the 6.25 level at the beginning of 2018. But, in a few days it fell back to around 6.65. Fluctuations against the euro have been a little more important and the level which has just been reached (7.75) is sending back the Chinese currency at a year ago level but in a context with an increased volatility.
Are these evolutions expressing a new monetary strategy by China, aimed to answer to the trade war initiated by Washington or rather, are they revealing internal difficulties of the Chinese economy? In 2018, growth seems to be robust. The country has adopted as an objective a GDP growth rate between 6% and 6.5%. During the 1st quarter, this target has been over exceeded with a 6.8% growth rate. An exceptional cold wave has generated a strong rise of power production (+10%) but the foreign trade contribution has been less favorable than in the past. Imports (+11.7%) grew faster than exports (+7.4%) and current account balance has only been slightly positive (1% of the GDP), despite a still very high trade surplus. The Chinese economy is really on the way, on line with the choices of the authorities, of a full rebalancing with a strong rise of household consumption. Chinese tourist expenditures abroad are also growing at a very fast rate. Inflation (+2%) is still moderate and financial unbalances inside the country are not increasing anymore. Household are starting to reduce their indebtedness and state-owned enterprises are improving their financial situation which contributes to reduce risks.
So there are no internal reasons to depreciate the Yuan. Would it be a good method to replicate to the American duties? Nothing is less sure. The first victims of these new border taxes will be the American consumers and enterprises. It is these last ones which, through their delocalization strategies have contributed to the appearance of that huge trade deficit, over 350 billion dollars in 2017 which so much appalls the American president. It is also big retailers, Walmart being atop of them, which have chosen their suppliers in China. So Beijing should wait that the discontent which will inevitably result from the increase of these taxes will be strong enough in the U.S. to push the administration to open a discussion which will permit to it to return to the previous situation without losing its face.
To launch an aggressive exchange rate policy would also damage the strategy followed for a long time by the country regarding the internationalization of its currency and its admittance among the major world ones. And, in China long term has always had the priority against short term. It is highly likely that Beijing will not put into question the progresses accomplished during the past which have allowed, notably, the Yuan to enter into the basket of reserve currencies. The current monetary policy, slowly but definitely, favors foreign transactions liberalization and the downsizing of the list of foreign investments submitted to restrictions is going in that direction as was, in the past, the broadening of the Yuan fluctuation margins. The opening of Chinese financial markets to foreign investors is still a priority. At the end of March, the amount of Yuan-denominated bonds detained by foreigners has reached 200 billion dollars, a 60% rise in a year. An aggressive devaluation policy would put into question the attractiveness of that market as of the stock market at a time when Chinese A-shares have just been accepted to be included in major stock markets index.
The most important message issued by Beijing is not related to the value of its currency. It regards the management of its currency reserves, which overpass 3 000 billion dollars. For years, China is, along with Japan, one of the most important lenders to the United States which issue Treasury Bonds to finance its twin deficits, the budget one and the balance of payments one. China central bank holds them for an amount superior to 1 000 billion dollar. For some weeks, that amount is slowly but deliberately reduced. Washington could soon be confronted to difficulties to finance its deficit which is sharply increasing due to the fiscal reforms decided by Donald Trump. Beijing has no interest in rushing things because any creditor depends of the ability of its debtor to save the value of the debts it owns. But there is here a subtle but powerful message. It is on these issues that, without any public statement, a discussion could start to calm tensions.
At the end, Beijing and Washington have interest to reach a deal. Hong Kong and Shanghai stock markets have fallen by more than 15% since the beginning of the year due to the risks carried by a real trade war. On his side, Donald Trump is anxious about the consequences on the purchasing power of American people of the rebound of oil prices, even if a high price has always been an objective for American producers, and it is even more the case since the shale oil revolution. This anxiety will increase when will appear the consequences of the increase of customs duties on the level of life of American consumers.
Much more than a manipulation of currencies or a possible but unlikely devaluation of the Yuan, it is the consequences of Donald Trump projects on the daily life of his population which should make the American president see reason, which would calm financial markets and allow the return to sound conditions for foreign trade.