So much for China risk
Movement of the yuan vs the dollar during the past two months has nothing much to do about China
China’s currency rose sharply against the US dollar during the past several days. This had nothing in particular to do with China: the dollar weakened against the euro and other currencies, and China’s monetary authorities tie the yuan to a basket of currencies including the euro.
More nonsense is written about the yuan than any other traded item in world markets. For example, one Anne Stevenson-Yang claimed in a recent Bloomberg commentary that a weaker CNY would “spark a Chinese debt crisis.” Why? Because ” a stable renminbi is a key plank in the leadership’s promise to its people,” and a weaker currency will lead to panic outflows.
Except that the currency hasn’t been weaker; the dollar has been stronger. We know that because CNY has been stable against the euro. It’s the dollar that’s moving not the yuan. When President Trump told CNBC July 20 that the Chinese currency was “dropping like a rock,” he should have said that the US dollar was rising like a balloon. This week it came down again.
At the Wall Street Journal, a certain Nathaniel Taplin argued on August 7 that CNY was vulnerable because China is exporting less and importing more, reducing its trade surplus. More of China’s growth was driven by consumption, Taplin noted, and that required more imports. According to Taplin, “the changing trade picture should increase Mr. Trump’s leverage over China.” The argument suggests that Taplin is arithmetically challenged.
As the chart shows, the Chinese currency weakened as the euro fell from about 1.16 to 1.13 dollars, and recovered when the euro recovered.
If we look closely at the past six months, two factors explain virtually all of the change in the CNY exchange rate with the US dollar. The first is the euro exchange rate. The second is the People’s Bank of China benchmark short-term interest rates, the seven-day repo rate.
The chart below shows the behavior of the PBoC’s short-term rate and the euro exchange rate vs. the yuan during the past six months (end of March to present).
In fact, these two factors — the short-term central bank lending rate and the EUR exchange rate — explain virtually all the movement in China’s currency.
China reduced domestic interest rates in response to the threat of US tariffs. It sought to replace foreign demand that might be lost due to trade war with domestic demand.
This isn’t the first time that political leaders and financial commentators have embarrassed themselves while discussing China’s currency. In 2015, virtually the whole of the financial punditeska claimed that a massive run was underway out of Chinese assets. This was comprehensively refuted by the Bank for International Settlements in early 2016. As I reported at the time:
The real story is much less exciting. Chinese corporations paid down dollar debt and reduced offshore yuan deposits in anticipation of a decline in the yuan against the dollar during the third quarter of 2015, Macauley and BIS colleague Chang Su show. During the long years of yuan appreciation against the dollar, Chinese corporations took out loans in dollars, expecting to pay them back in appreciated yuan. Now they are repaying dollar loans. They are also shrinking their holdings of offshore yuan deposits, which they accumulated in anticipation of a rising yuan.