China Shuns Currency War of Competitive Depreciation



THE recent weakening of the RMB, or yuan, against the U.S. dollar, resulting in the Black Monday and Tuesday of China’s stock market has given certain countries the pretext to depreciate their currencies, and is blamed for sending shockwaves through the world’s primary commodity market. Amid voices that accuse China of waging a currency war, the market expectation of further big cuts in RMB exchange rates grew. The latest move by China’s central bank to cut the requirement reserve ratio (RRR) – the amount of reserves banks are required to hold – and benchmark interest rates are deemed by many market players as stepping up devaluation pressure on the Chinese currency. In these circumstances the speculative capital that attacks the RMB in anticipation of a currency crisis is piling up swiftly.


By measure of the yearly average exchange rate, the RMB gained strength against the U.S. dollar for 17 consecutive years since 1997, rising from 8.2898 yuan per dollar to 6.1428 yuan last year. The latest development in the exchange rate is nothing but a manifestation of a more market-based exchange rate formation mechanism under which the value of the RMB may shift both ways. The recent weakening was not out of the blue; it was already taking place in its forward exchange rate on offshore finance markets. It also happened against the backdrop of big dips in the value of several currencies against the U.S. dollar, including both developed and developing economies. The euro and the Japanese yen had both depreciated by 18 percent, the British pound by nine percent, the Australian dollar by 23 percent, the Canadian dollar by 18 percent, the South Korean won by 12 percent, the ruble by 40 percent, the Brazilian real by 34 percent, and the Indian rupee by six percent. By comparison, the decline in the RMB is too slight to invoke a “currency war” as proclaimed by some. 


Seen over a longer time frame, the current weakening of currencies against the U.S. dollar is the outcome of quantitative easing (QE) adopted by Western countries from 2009 to 2010, which was referred to as a currency war at the time. I predicted in several of my earlier essays that the biggest onslaught from this war would be felt more in its second stage – when Western central banks re-tightened their monetary policies – rather than in the first stage when they eased money supply, and asset bubbles consequently built up in emerging markets. If some people insist on calling the current exchange rate fluctuations a war, it is one started by time bombs planted years ago by the central banks of Western countries.


All in all, we can conclude that the fundamentals of the economy don’t support continued sharp falls in the value of the RMB, and there is no motivation for China’s policymakers to start a currency depreciation race. The RMB should and will remain stable.


It is not hard for anyone not blinded by irrational panic to see that the fundamentals of the Chinese economy don’t allow for continuous big declines of the RMB. Though China’s economic growth is slowing down in comparison with its past record, it is still stronger than those of other countries. The country has maintained commodity trade and current account surplus. The inflow of foreign direct investment (FDI) is still of a high volume. And China’s fiscal revenues and debts are both in relatively good shape among the world’s major economies.


Besides, over both the short- and long-term China’s policymakers lack the motivation to allow, let alone encourage, the RMB to decline, and have no intention of engaging in any competitive currency depreciation. I say so because big slides in the RMB will inevitably erode the balance sheets of Chinese companies with dollar-denominated outstanding debts. This is a dire prospect for the Chinese economy as the companies who have secured dollar borrowing from the international financial market are all major players in their respective industries. If their debt problems get out of hand, it is not hard to imagine the repercussions for China’s social and economic stability.


During the 1998 financial crisis in East Asia, a good number of conglomerates collapsed in South Korea. They had borrowed low-interest dollar debts in great quantities when the won was strong and getting stronger. When the crisis hit, the country’s foreign reserves hit rock bottom and the won plummeted, plunging these companies into insolvency. Aware of this lesson, China, with its foreign reserves of US $4 trillion, vowed not to make this mistake and ensured it had all the resources to avoid such a scenario.


From a long-term perspective, if a cycle of financial market convulsion – sharp RMB depreciation – appears, it means that the Chinese economy is in decline, as seen in Latin America. This is an unsavory prospect for China and one that it has guarded against all these years.


Of course the revision of the exchange rate can somewhat deflate the pressure on Chinese exporters since the RMB gained in value against the U.S. dollar for 17.5 years from 1997 to the first half of 2015 (according to the yearly average exchange rate). China, however, doesn’t pin its hopes of more exports on a weaker RMB. As mentioned, the export slump is the result of shriveling foreign trade globally. Leading the world’s foreign trade by a big margin for years, there is no way China can be insulated from this broader picture.


The significance of emerging economies to China’s foreign trade is also a factor in China harboring no interest in competitive currency depreciation. These economies are highly dependent on primary commodities, and any depreciation will effectively dampen their demand for Chinese goods.


My earlier research shows that of China’s US $3.6421 trillion in imports and exports in 2011, US $1.5681 trillion’s worth involved developed economies – Japan, the EU, Switzerland, Norway, Finland, the U.S., Australia, Canada and New Zealand – and the remaining US $2.074 trillion, or 56.9 percent, the emerging market. To break this down, of the total exports of US $1.8986 trillion, US $905.9 billion’s worth went to nine developed economies, while those amounting to US $992.7 billion, or 52.3 percent, went to the emerging market. As for imports, totaling US $1.7435 trillion, US $673.2 billion’s worth were from developed economies, while those worth US $1.0703 trillion, or 61.4 percent, were from the emerging market. Emerging economies thus take on more than half of China’s imports and exports.


The trend of China’s trade policies also corroborates that China has no inclination for competitive currency devaluation. During the recessions of the 1930s, while weakening their currencies Western countries, the U.S. in particular, piped out protectionist policies. The U.S. parliament passed the Smoot-Hawley Tariff Act in 1930, and President Herbert Hoover signed it into law despite protests from 36 countries and a petition signed by 1,028 economists in the U.S. This law hyped average U.S. tariff on imports to 53.2 percent, and then to 59 percent in 1932. This met with retaliatory actions by trading partners. As a result, international trade contracted sharply. The 1932 imports of the U.S. shrank to 31 percent of those of 1929, and the drop in its exports was even more staggering. By contrast, amid slowing growth in its economy and foreign trade over the past couple of years, China has been making strenuous efforts to increase imports. It has established new free trade zones and extended existing ones specifically for this purpose.


MEI XINYU is a researcher with the Chinese Academy of International Trade and Economic Cooperation of the Ministry of Commerce.