The Chinese Yuan, or Renminbi, has been a
widely-discussed topic for many years.
On the one hand, the U.S. government has complained
about China’s currency manipulation.
It has claimed the Yuan’s exchange rate
has been artificially kept low to give Chinese
exports an unfair advantage.
On the other hand, we have investors like
Kyle Bass, who think China might have a currency
crisis.
And the Yuan is overvalued.
If the yuan were to free float tomorrow it
would depreciate 30, 40% against the dollar.
But one thing almost everyone can agree on
is that China’s currency is not freely traded
like the US dollar and the British pound.
Its exchange rate has been more affected by
the Chinese Communist Party’s policies and
priorities than the market forces.
So in this video, let’s explore the history
of China’s exchange rate policy.
How has it been used to serve the Chinese
Communist Party’s interests?
And what it might look like going forward?
The “Planned” Exchange Rates In 1949,
the Chinese Communist Party took power in
China.
About four years later, in 1953, it officially
started implementing the planned economy,
which lasted until around 1978.
Between 1955 and 1971, the CCP fixed the exchange
rate at 2.46 Yuan per dollar.
This was relatively easy when the west was
under the Bretton Woods System.
Back then, the US dollar was backed by gold
and other major currencies were pegged to
the dollar.
When the system was ended by President Richard
Nixon, the world’s major currencies went
back to floating exchange rates and started
depreciating against gold.
The CCP then pegged the Yuan to a basket of
currencies.
And at one point, the exchange rate reached
only 1.5 Yuan per dollar.
There was no foreign exchange market in China.
Beijing simply maintained the exchange rate
by balancing its imports and exports, which
were totally under its control.
It is not surprising that Beijing chose to
have a fixed exchange rate to other currencies.
Well, it was a planned economy, after all.
So why not “plan” the exchange rate as
well?
During this period, one of the CCP’s main
goals was to quickly industrialize and become
self-sufficient.
It was believed that the Yuan was overvalued
during this period.
This seemed to serve the CCP’s needs.
Although China’s economy was mostly closed
to the rest of the world, it had to sell agricultural
products in exchange for imported machinery
to support its industrialization.
In the late 1970s, the CCP leader Deng Xiaoping
realized that its planned economy had failed.
To save the party from the economic disaster
it created, Deng realized things needed to
change.
The Dual Exchange Rate Era In 1978, the CCP
decided to gradually open up China’s economy
and adopt some free-market mechanism.
To do that meant the Chinese Yuan exchange
rate needed to be more market-based.
But it seemed the CCP was unwilling to give
up its purchasing power to the market.
In 1979, it cost China’s export companies
2.41 Yuan to receive 1 US dollar.
But they were not allowed to keep the dollar
and were forced to sell it to China’s central
bank at an official rate of merely 1.56 Yuan.
This was clearly counterproductive as no one
wants to buy something for 2.41 and sell for
1.56.
Under such a double standard, it made more
sense to import than export.
And China’s then small foreign reserve of
840 million US dollars in 1979 quickly dropped
to negative $1.3 billion in 1980.
Likely figuring that it cannot control everything,
the CCP decided to make a further compromise
to market forces.
In 1980, it implemented a so-called Foreign
Exchange Retention System.
It allowed export companies to keep about
10% of the foreign currencies earned.
In 1981, it set a commercial exchange rate
of 2.8 per US dollar, but the official rate
was kept at 1.5.
It wasn’t until 1985 that the official rate
was devalued to 2.8 per dollar as well.
In the same year, it established the Foreign
Exchange Coordination Market.
But the double exchange rate system continued
until 1994.
It seemed the CCP was torn between growing
the economy by adopting the free market and
maintaining its tight control.
The double standard it implemented was unfair
for Chinese companies and their trading partners.
What would it do when China’s economic growth
entered another stage?
The Major Devaluation of the Yuan The United
States labeled China as a currency manipulator
from 1992 to 1994.
But to attract foreign investment and increase
export, by 1993, Beijing had artificially
devalued its currency all the way to 5.8 Yuan
per dollar.
That was just the official rate.
On the Foreign Exchange Coordination Market,
the Yuan was once as cheap as 11 per US dollar.
This was clearly a recipe for black markets.
There we saw the first time the People’s
Bank of China intervened and supported the
Yuan with its foreign reserve.
Therefore in 1994, the CCP further yielded
to market forces and adopted a single exchange
rate system.
The official exchange rate dropped to about
8.7 Yuan per dollar.
This was the lowest point the Chinese Yuan
has ever officially been since 1955 versus
the US dollar.
But there was a catch.
The Foreign Exchange Coordination Market was
closed.
And exporting companies were again forced
to convert all their income denominated in
foreign currencies through China’s state-controlled
banks.
Effectively, the CCP was the only one allowed
to hold any foreign currency that came into
China, which maximized its power in affecting
the exchange rate.
Through this new currency exchange policy,
and paired with reform and opening, China
saw fast growth in its reported export and
foreign reserve in the following years.
Yuan Appreciation under External Pressure
Entering the 21st century, the U.S. and China
find themselves in very different economic
conditions.
The US entered into a recession.
The NASDAQ dropped from over 5000 points in
March 2000, to below 2000 points in September
2002.
In 2001 alone, the Federal Reserve cut interest
rates 11 times.
On the other hand, in the same year, China
joined the World Trade Organization.
Its trade surplus and foreign reserve kept
growing at high speed.
If the Chinese Yuan was freely traded, it
was very likely that the Yuan would appreciate
against the dollar very dramatically.
But the reality was the CCP did not want to
let a U.S. recession damage its competitiveness.
It maintained tight control of the exchange
rate, which stayed at 8.28 Yuan per dollar
from late 1998 to mid-2005.
As a result, the CCP received international
pressures to make the Yuan exchange rate more
market-based.
The U.S. Congress threatened to impose tariffs
on Chinese products if there was no revaluation
of the Yuan.
To avoid a potential trade war, on July 21st,
2005, the CCP made a small gesture by letting
its currency appreciate by 2% to 8.11 Yuan
per dollar.
International pressure was not lifted because
of the small change.
So after that, the CCP further allowed the
Yuan to appreciate and expanded its daily
trading range, known as the managed float.
By 2014, its currency rose to just above 6
Yuan per dollar.
And from 2005 to 2014, its foreign reserve
kept growing despite a drop in trade surplus
caused by the 2008 global financial crisis.
Push for Global Currency In 2010, China became
the second-largest economy of the world.
With that raised the CCP’s ambitions.
As early as 2009, Zhou Xiaochuan, the governor
of China’s central bank, wrote an essay
challenging the U.S. dollar as the global
reserve currency.
Since then, whether the Yuan will replace
the dollar has become an ongoing discussion.
But China’s reported GDP growth began slowing
down.
And some favorable trends for Beijing took
a turn between 2013 and 2015.
China’s foreign reserve peaked in 2014 and
then started dropping.
On the other hand, its external debt was rising.
In 2015, the dollar became stronger against
other currencies.
This put the CCP in a dilemma.
If it let the yuan drop, its foreign currency-denominated
obligations will be more expensive.
And foreign investors might lose confidence.
But if it were to make the Yuan rise with
the US dollar, China's economic slowdown might
worsen.
So what did the CCP do?
On August 11th, 2015, the central bank announced
another significant change to its managed
float exchange rate policy.
It allowed a broader trading range and gave
the market a higher weight in setting the
midpoint price.
As a result, the Yuan depreciated about 2%
in one day from about 6.12 per dollar to 6.23.
And to date, the Yuan has not gone back up
to its 2014 highs.
It seemed the CCP further yielded to market
forces, but that was far from making the Yuan
trade freely, and it still can intervene when
it doesn’t like where the exchange rate
is going.
Nevertheless, the slight change in policy
let the CCP receive something it wanted.
Later that year, the IMF admitted the Yuan
to its basket of reserve currencies, which
became official in late 2016.
This was a step for the CCP to make the Yuan
a global currency that can challenge the US
dollar.
As the U.S.-China tension continues, we should
expect the CCP to make further attempts to
make its currency appeal to the rest of the
world.
What comes next?
To better understand a country’s exchange
rate policy, it is helpful to become familiar
with the economic concept named the Trilemma,
also known as the Impossible Trinity.
It states a country cannot have free capital
flows, independent monetary policy, and fixed
exchange rate at the same time.
Most advanced economies choose the first two
and let the market decide their exchange rates.
Hong Kong pegs its currency to the US dollar
and therefore gives up independent monetary
policy.
The CCP has its own monetary policy, imposes
strict control on capital flow, and tightly
manages the Yuan exchange rate.
Will China’s economic condition allow it
to do so going forward?
We’ll discuss it in future videos.
The Chinese Yuan has never been freely traded
and freely convertible.
Therefore its real value could be harder to
estimate than other major currencies.
But one thing is almost guaranteed.
The Chinese Communist Party will continue
to adjust its exchange rate policies to best
suit the party's agenda.
Therefore knowing the CCP’s past and future
priorities might help predict where the currency
is going.
Like Winston Churchill said quote: “The
farther backward you can look, the farther
forward you can see.”
What’s your opinion about the Chinese Yuan?
Leave your comments below.
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