Recently, the U.S. has been pressuring China on the Chinese yuan’s movement. From the FRED graph above, the yuan was on a steady appreciation path against the dollar until this February, after which it depreciated significantly (down 3% against the dollar) and reached the bottom on March 20. The Treasury Department said that the yuan’s depreciation would “raise serious concerns” if Beijing is moving away from the plan to allow the market force to have a greater impact on the yuan’s exchange rate, especially if Chinese officials are at the same time citing greater flexibility in the currency’s value.
So is the Chinese central bank really altering the path of the yuan’s liberalization? From my perspective, the yuan is still on an upward, market-based trend, in spite of some short-term headwinds that have triggered monetary intervention.
Starting in late February, the Chinese central bank has been engineering the decline in the yuan by instructing state-owned banks to buy dollars. In addition to the government-guided purchase, the daily trading band was widened to allow the yuan to move as much as 2% on either side of the parity rate on a daily basis. The reason behind was to drive out international speculators who had been pouring tremendous capital (“hot potatoes”) into China in anticipation of the endless appreciation of the yuan. The influx of speculative capital made the Chinese government harder to manage its economy, triggering potential housing bubble and inflationary pressure. From the long-run view, the central bank is trying to introduce greater two-way volatility of the yuan before allowing the market force to play a more critical role so as to ensure its stable movement and promote its international use as an important global currency.
Personally, I think the yuan’s decline is also attributed to China’s economic slowdown, signaled by shrinking exports and industrial production, as well as yet-to-stimulate domestic consumption. The country’s GDP is expected to grow by 7% in the first quarter, a level lower than the 7.7% expansion last year, making investors sell the yuan on growth concern.
If we consider the broader picture, the yuan has been appreciating against the dollar for almost 10 years, despite some short-term devaluation. From the FRED graph below, we can see that the yuan was traded against the dollar at a flat rate with almost no change until the de-pegging in June 2005, and then it appreciated significantly for 3 years until the burst of the 2008 global financial crisis. After that, the yuan appreciated at a slower pace and was traded mainly in the range of 6.0 to 6.6.
Although China is in no hurry to halt the recent slide of the yuan and remains cautious about any potential resurgence in the speculative appetite for the currency, I believe the yuan will resume its appreciation path modestly in the near term because of the Chinese government’s stimulus package for growth, increasing capital inflow into Asia, and political pressure from Washington.