Why yuan devaluation is not in China’s best interests and it’s time for Beijing to stop the free fall

  • David Brown says an adverse midterm election for Trump could see him push for a weaker dollar, resulting in a currency war that further rattles markets
  • A weaker yuan will intensify the Chinese economy’s focus on exports, in contrast to Beijing’s intention of concentrating on domestic consumption
PUBLISHED : Monday, 05 November, 2018, 3:03pm
UPDATED : Monday, 05 November, 2018, 10:28pm

It is well past the time for Beijing to tame the weak yuan. Over the past two years, China’s currency has suffered a wild roller-coaster ride, a stomach-churning experience for exporters who need currency stability not wild foreign exchange volatility to plan ahead with confidence.

The weak yuan has also given the economy the wrong signals by back-tracking on Beijing’s commitment to shift the focus away from export-led growth to domestic consumption. There are far better ways to revitalise domestic growth than the blunt force of yuan devaluation.

The strong US dollar could prove a very fickle friend for China, especially if Washington starts playing its own game of currency manipulation to pressure Beijing in the trade war. A hostile US President Donald Trump could prove a dangerous risk, especially in a backlash to any possible US midterm election shocker this week. If his back is up against the wall, it might be hard to resist the temptation to plug for a weaker dollar to gain more economic advantage over China. An all-out currency war would be a regime shift that markets can ill afford right now.

It is time for Beijing to take a moral lead and set a ceiling for the dollar/yuan exchange rate to go no higher than 7. Recent hints have suggested some stabilisation may be preferable now, so all Beijing needs to do is lean with the wind and give recent yuan appreciation some gentle endorsement to reinforce the move.

Central bank to sell yuan bills in Hong Kong to help prop up flagging currency

After all, what policymakers want for their currency, they generally get – if they push hard enough. Beijing just needs to be more explicit on its aims. Betting against currency speculators is one thing, but Beijing needs a credible forex policy fix for the future.

It is pointless for markets to look to Trump for credible guidance as the president’s salvoes are too mercurial to rely on. Last week, markets were fired up by his comments that the trade war may be heading towards a positive conclusion, only to be contradicted by his top economic adviser, Larry Kudlow, suggesting a US trade deal with China was indeed nowhere close.

The market’s attitude has also been soured by Beijing’s apparent benign neglect towards its currency

The fact that the yuan staged its biggest two-day rally in a decade after Trump’s trade deal comments underlines how much dollar bulls may be overstretched, while China’s currency sell-off has gone too far. It is a prime opportunity for a yuan short squeeze.

There is nothing sacrosanct about a US dollar-Chinese yuan exchange rate of 7 as a barrier. After all, the market’s expectations for the currency over the next year are extremely wide, ranging from USD/CNY at 6.3 on the yuan’s upside to USD/CNY at 7.3 on the downside. The disparity is because the underlying fundamentals are so mixed.

The dollar has enjoyed a strong momentum trade over the past year, thanks to robust US economic growth and interest rate tightening by the Federal Reserve. Meanwhile, China’s economy has lost vital growth impetus and monetary policy is still biased towards more easing. The market’s attitude has also been soured by Beijing’s apparent benign neglect of its currency. This needs correcting.

If Beijing wants to build currency stability, it should not turn a blind eye to a break above USD/CNY 7. It would open up a box of trouble over the future and reinforce Washington’s notions that China is a currency manipulator.

If Beijing wishes to claim the moral high ground in the trade war, there is no better time to put a firm floor under the yuan and stake its case for some reasonable appreciation ahead. Stabilising the yuan into a 6.50 to 6.75 yuan range would still leave the currency competitive and provide much better price certainty for China’s embattled exporters.

As yuan teeters close to 7 per US dollar, what’s China’s next move?

From peak to trough this year, the yuan has depreciated by around 10 per cent. But this is misdirecting key resources towards exporters when Beijing should be channelling stronger stimulus into the domestic economy to boost consumption and investment. China’s economy is crying out for a much bigger fiscal spend.

The time for trade wars and currency instability should end and America and China should move on to better harmony and boosting global growth.

David Brown is chief executive of New View Economics