No ‘competitive devaluation’ in China

US criticism of Beijing does not stand up to scrutiny

When President Donald Trump’s administration asserts that China steals intellectual property, violates foreign investor rights, engages in wrongful wholesale subsidisation of the economy, and raises questions about industrial policy pursuant to ‘Made in China 2025’, it stands on solid ground.

Its assertions about Chinese currency policy are much shakier. The president’s allegations about renminbi ‘manipulation’ do not stand up to scrutiny.

Now, Treasury Secretary Steven Mnuchin has made clear the administration wants to be sure China ‘is not doing competitive devaluations’. But this assertion also does not stand up to scrutiny.

The dollar is up across the board, especially against emerging market currencies. Since early April, when the renminbi was at its strongest this year, the dollar is up by around 10% against the Chinese currency. It is up roughly a similar amount against the Federal Reserve’s ‘Other Important Trading Partners’ index – an index of emerging markets. Against the Indian rupee and Indonesian rupiah, the dollar is up more than 10%.

While the renminbi is down against the dollar, it is up against its other trading partners. Overall, the Chinese trade weighted basket is down 4.5%.

The reasons for the dollar’s strength are clear. The US economy is growing strongly. The Fed is raising rates. The large expansion in the US fiscal deficit, coupled with rate normalisation and ‘quantitative tightening’, reinforce upward pressure on US rates.

On the Chinese side of the ledger, the economy, though strong, has shown signs of softening over the course of 2018. Beijing’s macroeconomic policy is clearly aimed at accommodation, providing support to the economy.

Trade tensions are contributing to the softening Chinese economy and a weaker currency. When Trump threatens, or actually hits, China with trade tariffs, the renminbi depreciates. As tensions rose, pressures on the renminbi intensified. Many market participants see China’s economy as more vulnerable to trade tensions with the US, given the much larger amount of Chinese exports to the US than vice versa.

The contrast between US and Chinese cyclical developments is captured in bond spreads. The spread of Chinese over US two-year yields has narrowed to only around 30 basis points from around 1.25% in April. The spread between the Chinese and US 10-year yields has narrowed to around 40 basis points from around one percentage point in early April. The narrowing interest differentials are impacting trading in renminbi and the dollar. Chinese stocks are also well off – some 12% since early April.

When a country pursues monetary policy easing, all other things being equal, its currency tends to fall in value. However, China’s monetary policy easing – such as the recent cut in reserve requirements – seems directed at supporting a softening economy. From this standpoint, China might be better served by relying more on fiscal policy, thereby lessening the burden on monetary policy.

In the meantime, Chinese statements and other actions clearly suggest China has little wish to see the renminbi fall, including against the dollar. Premier Li Keqiang at a World Economic Forum event in September said, ‘Persistent depreciation of the renminbi will only do more harm than good to our economy.’ Yi Gang, governor of the People’s Bank of China, has repeatedly called for a stable currency.

The authorities recently reintroduced their ‘countercyclical factor’ at the daily renminbi fixing, allowing them to signal support for a stronger currency. They have also sought to squeeze short-sellers. If anything, China has been modestly intervening to prop up the renminbi.

China is well-advised to resist renminbi depreciation. In 2015-16, when markets realised that renminbi appreciation was not a one-way bet, massive selling pressures ensued, which Beijing resisted by selling $1tn in reserves. A sharp downward move, perhaps past the potentially psychologically important point of Rmb7 per dollar, could trigger major renewed selling pressures.

On balance, China is not engaged in ‘competitive devaluation’. The renminbi’s decline primarily reflects a strong US economy as well as contrasting cyclical developments in China, notwithstanding the views of Beijing’s officialdom.

The US wants a strong domestic economy without a strong dollar. China wants more accommodative macroeconomic policies without a weaker renminbi. They both want their cakes, and to eat them too.

Mark Sobel is US Chairman of OMFIF.

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