Opinion | China won’t shoot itself in the foot by weaponising the yuan
As in the 1997 Asian Crisis, holding the line on the currency gives Beijing an opportunity to build on its soft power and position the yuan as a genuine international and reserve currency
Since June 1, the Chinese yuan has depreciated by 6 per cent against the US dollar. This depreciation has been sharp, reminding investors of the “yuan tantrums” of August 2015 and January 2016. Will Beijing use the yuan as a mercantilist tool to counter the impact of the protectionist measures from the US? Is the Chinese economy still healthy, or does this yuan depreciation – as well as weakness in the Chinese equity markets – signal a more sinister outlook for China? Could the yuan experience the types of market-destabilising and sentiment-sapping depreciations seen in 2015/16?
Not really. It will be quite unlikely for the Chinese authorities to adopt a mercantilist yuan policy when it has avoided doing so since the 2005 yuan float. Most of us remember how Beijing bravely held the line on the yuan during the 1997 Asian Crisis. As in 1997, this is a prime opportunity for China to build on its soft power to help turn the yuan into a genuine international and reserve currency. The value to China from branding the yuan as a nominal anchor rather than a source of instability seems much higher than potential short-term gains, if any, from a maxi-devaluation.
Let’s put the recent yuan depreciation into perspective. The yuan has weakened by 5 per cent this year vis-à-vis the dollar, during which time the dollar index has appreciated by around 4 per cent against a wide range of currencies. While the movements in recent weeks have been uncomfortably sharp, the yuan depreciation hasn’t been outstanding, looking at year-to-date changes.
Second, the yuan is much more valuable to China as a nominal anchor. There is growing pent-up demand – of a healthy type, similar to what happened in Japan 30 years ago and in other Asian countries 15 years ago – for Chinese households to divest from their home (yuan) assets. At the same time, Chinese financial assets are significantly under-represented in international investors’ portfolios. After about US$1 trillion in outflows since 2014, there’s another estimated US$1.5-2 trillion of pent-up demand in China for foreign assets.
No, China is not weaponising the yuan in its trade war with the US
To prevent the lopsided capital outflows from triggering more spasms in the currency markets, Beijing will need to do more than just maintain tight capital controls, it will need to proactively promote Chinese financial assets to foreign investors. Stable yuan expectations would be a necessary condition for this.