US president-elect Donald Trump enjoyed much mileage from his castigation of China as a currency manipulator that used an artificially weak yuan to stoke exports and steal American jobs. The message may have hits its mark with voters, but it’s a couple of years out of date.
Since the summer of 2014, capital has been flowing out of China at such a rapid rate that the monetary authorities have been going all out to slow the yuan’s slide against the US dollar and prop up flagging confidence in the world’s second-biggest economy.
The dollar’s surge in the aftermath of Trump’s November 8 victory has exacerbated the slump, with the yuan hitting an eight-year low of 6.9235 against the greenback on November 24. China’s currency recently traded at 6.9118, according to Sina.com.
Investors are still concerned that there are soft patches lying ahead for the Chinese currency, especially given that the yen weakened as much as 10% against the greenback during the same time, making Japanese exports relatively cheaper.
In the face of continued bearish sentiment toward the yuan and stubbornly high demand for the US dollar, the government is ramping up signals of its intention to support the yuan.
On Friday, the Wall Street Journal reported that Beijing is tightening controls on Chinese companies looking to invest abroad. And on Sunday, in an exclusive interview with the state-run Xinhua news agency, People’s Bank of China vice governor Yi Gang restated the official line that the yuan remains strong and stable against a trade-weighted basket.
That is certainly true, but so too is the extremely high cost for Beijing to fend off the market demand to sell yuan and buy dollars.
A simplified way of gauging the PBOC’s currency intervention is to look at the month-on-month changes in foreign exchange reserves.
China’s forex pile fell to US$3.12 trillion at the end of October, almost US$900 billion off the June 2014 high of US$3.99 trillion. To put that in perspective, China has lost more foreign reserves than Taiwan and South Korea have in their coffers combined.
In short, by using its reserves to buy yuan in the open market Beijing hopes to keep the exchange rate vis-a-vis the US dollar relatively steady and avoid any disorderly rush for the exit.
The forex mountain has dwindled despite the country’s persistently large trade surplus — which count as an inflow for the reserve — that has averaged close to US$50 billion a month over the past two years.
So what explains the persistent capital outflows from China since June 2014? Robert McCauley and Chang Shu from the Bank for International Settlements pointed to two main narratives in an article published in March.
The first is one in which investors are selling their mainland China assets in order to pull funds out. The second describes Chinese companies paying down foreign currency debt — mostly US dollar. The authors noted that they favored the latter view, but also highlighted an element missing in both: the rapid decline in offshore yuan deposits.
Using data reported to the BIS by banks outside China, they found that declining offshore yuan deposits in East Asia accounted for about 50% of the cross-border outflow in the third quarter of 2015 — which was the point at which the fund exodus gathered substantial momentum.
“In response to lower demand for renminbi deposits, banks in these and other jurisdictions drew down their cross-border renminbi deposits with mainland banks, leading to a capital outflow of US$80 billion (PBOC data) that amounts to half of the US$163 billion outflow,” the report said.
About half of the world’s offshore yuan is held in Hong Kong. Data from the Hong Kong Monetary Authority shows yuan deposits in the city continued to fall this year, with 185.6 billion yuan drawn from accounts in the first three quarters, adding to the 152.5 billion yuan drop in 2015.
The global picture is even more dramatic. Yuan deposits held offshore slumped to 1.13 trillion yuan as of September from 2.37 trillion yuan at the end of 2014, PBOC data show.
The conversion of yuan deposits for other currencies accounts for US$200 billion worth of capital outflows in 2015 and so far in 2016.
The BIS economists also suggested keeping a close eye on falling foreign currency loans at banks inside China.
When companies in China pay off foreign currency debt this creates an equivalent demand for the US dollar, for example, that counts as a capital outflow.
Foreign currency loans peaked at the equivalent of US$610.4 billion in April 2014, having climbed steadily since 2009 as Chinese borrowers took advantage of tumbling US interest rates during the global financial crisis. Expectations that a weakening yuan would raise the cost of servicing foreign currency debt has spurred Chinese firms to repay their loans. The balance now stands at around US$374 billion.
The evolving dollar peg
China’s interventions to support the yuan show how far the country has come in liberalizing its currency system.
For 11 years before July 2005, the Chinese currency was fixed at 8.28 to the US dollar. It was then that the State Council embarked on a major foreign exchange reform with a one-off 2% revaluation. Beijing has gradually let market forces play a bigger role in setting the exchange rate, permitting wider trading ranges and volatility.
Over the decade record-setting economic growth that followed, the yuan steadily appreciated as investors saw it as a safe “one-way bet.”
Demand for yuan and PBOC intervention to slow the currency’s rise saw China’s foreign exchange reserves balloon 8 1/2-fold and fueled the criticism of Beijing as a currency manipulator.
Now though, as concern over China’s slowdown grows, so the tide of capital has turned 180 degrees — and undermined Trumps central allegation.