By Oren Laurent
President, Banc De Binary
The rivalry between the U.S. and China, two politically-opposed world superpowers, is well known. So what happens when the countries share an economic goal? In its twice-yearly report to policymakers in Congress, the U.S. Treasury pointedly stated that the Chinese yuan is “significantly undervalued” and that a stronger currency would be better for the global economy. Analysts need to question if this would also be good for China, and if so, will they cooperate. Let’s take a look from both sides.
Unlike the dollar and euro, the value of the yuan is not determined by the free market but is kept within set limits of other currencies. So far this year the strictly-controlled yuan, also known as the renminbi, has fallen 2.3% against the dollar, making it Asia’s worst performing currency. Last month the central bank doubled the range in which the yuan is allowed to trade. Given the recent concerns about an economic slowdown, this served as a green light to investors to sell the currency.
The United States is frustrated that Chinese policy makers are purposefully depreciating the yuan in order to make goods cheaper internationally and gain a trade advantage for its own exporters over the global competition.
Traditionally the Chinese economy has indeed been export driven and a lower currency served that well. However, China’s decision makers have been vocal about their desire to make the economy less dependent on manufacturing exports, and more reliant on local consumers.
The U.S. argues that a stronger currency would help on that front, making foreign imports cheaper and more accessible to the population. The Treasury also believes that, “A market-determined exchange rate would… give Chinese authorities greater control over liquidity creation and domestic monetary policy.”
Yet China seems in no hurry to act. Despite the currency’s slide this year and their wish to increase domestic consumerism, the country has so far refused to bow down to U.S. pressure. According to an official at the country’s central bank, the People’s Bank of China, “Barring a sharp decline that could destabilize the country’s economy, the PBOC is unlikely to intervene to make it higher.”
Why would that be? Analysts in Beijing argue that depreciation is necessary in order to drive out short-term speculators who expect the currency to rise and could put pressure on it and cause it to appreciate unnaturally. China may hope that in allowing the current depreciation, they will create a higher degree of unpredictability and convince traders that the currency could as easily weaken as it could strengthen.
Despite short-term volatility however, there seems to be consensus that the currency will appreciate in the longer-term. Fundamental data does suggest that the economy will improve later in 2014. It is unclear whether Washington would implement congressional action to penalize China and force them into appreciating the currency, or whether mere words and the impending possibility of this would serve the same purpose.
Beijing may be acting cool right now, and will be politically loath to be seen immediately obeying Washington, but the Government will be well aware that a rise in the currency’s value could serve their long-term interests and make the yuan a more important global currency. On balance, a rise seems somewhat inevitable. Will it happen as quickly and substantially as the U.S. would like? Probably not.
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