Beijing can slow, not stop, the yuan’s fall

Talons out. Robert Lighthizer. Mike Walz. Marco Rubio. These renowned China hawks are not the names Beijing wants popping up in President-elect Donald Trump’s early cabinet appointments. Markets agree, as the yuan has fallen about 2% against the dollar since Trump’s victory at the polls. Downward pressure will mount if he follows through on threats to raise American tariffs on imports from China to as much as 60%.

Any additional levies would drag on growth in the world's top exporter. Moreover, Trump's inflationary trade and tax policies are tipped to keep U.S. interest rates high and the dollar strong. His first round of tariffs on China, for example, resulted in a 5% depreciation of the yuan against the greenback in 2018.

A repeat would be a headache for China's economic planners, particularly since President Xi Jinping designated a strong yuan as a priority for making China a “financial powerhouse”. A weak currency can also worsen deflation and eat into consumer demand at a time of slowing economic growth.

Strategists have flagged 8 yuan per dollar as the likely floor Beijing will tolerate, but that may overestimate its ability to control the exchange rate.

Granted, policymakers have plenty levers to pull, such as tweaking the midpoint around which the currency can trade 2% in either direction against the dollar. That trading band is frequently used to push back against depreciation. Regulators can also order state banks to buy yuan and sell dollars; raise limits on dollar lending; and instruct currency desks to not trade below a certain threshold.

But the yuan's exchange rate, though tightly managed, is still subject to market pressures, and such measures have only managed to slow the pace of currency moves in recent years, not fully halt or reverse them.

One obvious alternative is to tap China’s $3.26 trillion in foreign reserves. But the central bank’s effort in 2015 to draw a hard line in the sand was taken as a challenge by traders shorting the currency, forcing authorities to burn through $1 trillion of reserves to bring the exchange rate out of a tailspin. This has made central bankers hesitant to visibly deploy reserves for fear of painting a target on their own back and spooking markets. Intervention might also set back progress on making the yuan an international currency.

So while Xi may not want to see the yuan fall past a certain point, policymakers probably don’t have the means to prevent it— especially if the White House goes full bore on tariffs. The fate of the reniminbi, or the people’s currency, now lies in Washington’s hands.

Context News

The Chinese yuan has fallen about 2% since the election of Donald Trump as president of the United States on Nov. 6. He has pledged to impose a 60% tariff on all imports from China.

Trump has asked Robert Lighthizer to return to the role of trade representative, which he held during the first U.S.-China trade war, the Financial Times reported on Nov. 9. Trump has also nominated China hawks Marco Rubio and Mike Waltz for secretary of state and national security advisor, respectively.