China’s currency has hit its lowest point versus the dollar since the financial crisis a decade ago, and it is fast approaching a key psychological level of 7 yuan per dollar.
Economists warn that a rapidly depreciating yuan poses a number of risks, including capital flight and market volatility. Some analysts say those risks, as well as the specter of an escalation of the US trade war, may outweigh any benefits policymakers see in offsetting tariffs through a weaker currency.
Brad Setser, an economist at the New York-based Council on Foreign Relations, summarized on Tuesday what he sees as the three main policy options for Beijing:
“One: Continue to manage the yuan against a basket, and defend the current band—which would mean no further depreciation against the basket. Any moves against the dollar then would be a function of the dollar’s moves against other currencies (at least so long as the yuan is at the weak edge of its band).
“Two: Adjust the band, and allow the yuan to depreciate to the weak edge of a new band. This could be done slowly, or it could happen abruptly. The challenge would be to set the new edge of the band after a period of depreciation (slow or fast), and then to defend the new weak edge of the band in a way that convinces the market that the yuan won’t fall further.
“Three: Let the yuan float down…until it finds a natural bottom.”
The first option, which Setser sees as the easiest path for China, financially speaking, comports with what many other economists see as the most likely course of action as Beijing tries to smooth over trade tensions and maintain market stability.
While the US did not label China as a currency manipulator following the release of a recent Treasury Department report, the Trump administration could always increase tariffs in response to a significant decline in the yuan’s value.