Yuan strength reflects dollar weakness as much as China’s economic recovery

China’s economic situation justifies some degree of yuan appreciation, but there is more at play than just renminbi strength. Rather, the US dollar has been weakening against several currencies, and this suits American interests

Neal Kimberley

Published: 1:30am, 16 Dec, 2020

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Beijing needs to be vigilant on the currency front. The strength of the yuan in recent months partly reflects China’s impressive economic recovery from Covid-19 but the rise of the renminbi is not all about China. It’s also about the currency market’s wider and well-grounded disillusionment with the US dollar.

China’s own economic situation undoubtedly justifies some degree of yuan appreciation. But Beijing must also be mindful that when a rising renminbi is more a function of US dollar weakness – which Washington may not directly be pushing for but is also doing nothing to discourage – that may not suit China’s own economic interests.

It’s indisputable that China’s economic recovery from the pandemic has been striking, especially when compared to other major economies where attempts to contain Covid-19 have so far been less effective, and also that, as other economies do start to pull round, Chinese exporters are already satisfying resurgent overseas demand.

Indeed, China’s customs agency reported on December 7 that exports grew by 21.1 per cent in November year on year, expanding at the fastest pace in almost three years and representing a sixth consecutive month of growth.

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It’s also indisputable that central banks in many major economies continue to use ultra-accommodative monetary policy tools in their attempts to mitigate the economic impact of the pandemic.

In stark contrast, the People’s Bank of China has taken a more nuanced approach. Global investors have consequently been drawn towards relatively high-yielding yuan-denominated Chinese government bonds.

These factors have helped drive greater demand for the renminbi, which has shown itself in the rise of the yuan versus the US dollar on the foreign exchanges.

From a trade perspective, and especially in an environment of rising US dollar-denominated commodity and energy prices, a stronger yuan is useful to China, but it is a double-edged sword.

The stronger the yuan gets, the more it erodes the competitive advantage of Chinese exporters and, even though China is moving towards a dual circulation economic model, that export sector is still important and has to be nurtured.

In the past, Beijing has acted to slow the pace of yuan appreciation against the US dollar, often provoking criticism from Washington in the process, picking up greenbacks on foreign exchanges and adding to China’s foreign reserves.

More recently, Beijing has been minded to allow market forces to determine the yuan’s external value, but there comes a point when China may feel it has a duty to act.

Official data published last week showed the value of China’s foreign exchange reserves increased by about US$50 billion in November, to US$3.18 trillion, the highest level since August 2016.

That rise was partly driven by broad greenback weakness that enhances the value of China’s reserve holdings of other currencies and gold when measured in US dollar terms.

China central bank officials see bigger global role for yuan as US dollar wanes

Whether Beijing stepped in to buy US dollars to arrest the pace of yuan appreciation is, as yet, unclear. But what is clear is that there is more at play here than just renminbi strength.

This is US dollar weakness. Call it benign neglect if you will, and Washington might not admit it publicly, but a weaker greenback surely suits US interests currently.

A weaker greenback makes US exports more competitive and perhaps, through higher bills for imports into the United States, encourages an uptick in US consumer prices.

Such an uptick would suit the Federal Reserve, whose mandate aims for maximum employment and price stability but equates the latter with annual consumer price inflation at a flexible average level of 2 per cent.

People stock up on groceries and water in Hollywood before tropical Hurricane Isaias makes landfall in Florida on July 31. A rise in the price of imports, due to US dollar weakness, would suit the Federal Reserve, which aims for consumer price inflation of around 2 per cent per annum. Photo: ZUMA Wire/dpa

As it is, evidence of broader US dollar weakness is plentiful. Australia might be embroiled in a serious trade conflict with China but that didn’t stop the Australian dollar hitting a 2-½-year high versus the US dollar last week.

Rising iron ore prices, led by Chinese demand, are supportive of the Australian dollar, but that argument doesn’t apply to the euro which has also been pushing higher against the greenback, even as the European Central Bank has unveiled measures that make euro-zone monetary policy even more ultra-accommodative.

The Bank of Canada understands exactly what is going on. “A broad-based decline in the US exchange rate has contributed to a further appreciation of the Canadian dollar,” the central bank stated in its latest policy statement released on December 9.

Beijing should take heed. China’s economic interests now require Beijing to be vigilant on the currency front, even if Washington won’t like it. Yuan strength is no longer all about China.

Neal Kimberley is a commentator on macroeconomics and financial markets