In a year of thrills, spills and chills, here’s something else that has not gone as Donald Trump expected: China’s currency is rising.
One of the US president’s most consistent gripes is how Chinese counterpart Xi Jinping is stealing jobs via an undervalued yuan. On the campaign trail and in the White House, Trump never misses a chance to complain that “currency manipulator” Beijing is “killing us.”
More recently, Trump even conflated a yuan rate with Covid-19 as he excoriated Beijing for unleashing a “scourge” on his re-election efforts ahead of November 3.
Perhaps Trump has not noticed the yuan’s steady rise – 4.3% in these past few months alone. Xi sure has. The People’s Bank of China just acted to slow the currency’s advance. It scrapped a two-year-old policy that made it expensive for traders to bet against the yuan.
Even so, things have changed. Unlike in the recent past, Xi’s team did not encourage declines – it merely ensured the rise unfolds in an orderly fashion. This tolerance seems a harbinger of reforms to come that augur well both for China and the world economy.
In Shenzhen on Wednesday, President Xi is expected to add detail to a massive master plan to transform Southern China into a world-beating technology hub.
That includes, as Xinhua reported, taking cooperation between Shenzhen and Hong Kong to a “higher level” as well as major new connectivities and investments.
Yet more attention should be paid to how a rising yuan helps facilitate this objective. Here are five reasons Xi’s Shenzhen vision will benefit from a strengthening yuan.
1: Chinese purchasing power
In 2020, China finds itself in the role of the sole global economic engine. As strategist Lim Say Boon of CGS-CIMB Securities puts it, China is the first post-Covid-crisis “normalized economy.”
Covid-19 may have started in Wuhan – as Trump reminds the globe at every opportunity – but China did a better job than most when it came to containing the virus and limiting its economic damage. Though China contracted 6.8% between January and March, it’s still seen to be growing 2% this year.
The data, Lim says, “tells a very consistent story of an economy that has almost normalized from the deep contractions in 1Q20. Yet, China is a normal economy in another sense. It hasn’t engaged in the extreme stimulus of many other economies, particularly the United States.”
This means China may once again be playing the locomotive role that it did during the 2008-2009 global financial crisis.
Then, solid mainland demand helped Asia avoid the worst of the Lehman Brothers crash fallout. And though China has advanced as an economic force since then, it is also the same game plan Bejing followed amid the 1997-98 Asian crisis.
It did that by resisting the urge to devalue, as Thailand, Indonesia and South Korea had done. It also filled a growth void in the region.
This time again, says analyst Udith Sikand of Gavekal Research, the rest of Asia will “hopefully sell into a market that is enjoying improved purchasing power.”
That could generate a lot of goodwill around Asia and beyond. It should also remind the globe that as Trump pours sand into the gears of global trade, China will increasingly play its part to generate growth.
2: Accelerating domestic consumption
A quiet and often overlooked shift from manufacturing to services is proving a boon for Xi’s economy in 2020.
True, nothing would propel Chinese growth faster than an export surge. In 2019, though, the share of private consumption in driving gross domestic product reached about 40%. China has a ways to go to match the 65% share in the US, but the economy is steadily becoming less lopsided in the direction of exporting cheap goods.
A strong yuan certainly injects buying confidence into China’s expanding middle class. The risk now, says Louis Kuijs of Oxford Economics, is that pandemic fallout “has slowed the move to a more consumer-oriented economy.”
A key worry, notes economist Shaun Roache of S&P Global Ratings, is that “households have decided to save more to guard against future risks.”
As such, it is in Xi’s best interest to gin up a new stimulus package to support households. Spending to date has been targeted mainly at businesses.
“Chinese officials are still far from comfortable employing the kind of direct-to-household stimulus that the US uses on a vast scale,” says analyst Andrew Coflan of Eurasia Group, “but they are increasingly embracing policy measures aimed at spurring consumption.”
Now is an ideal moment to boost investments in stronger social safety nets, including unemployment insurance, better healthcare and more generous pension provisions.
3: Globalizing the yuan for real
Regulatory changes announced over the weekend are aimed at honoring Xi’s pledge to let market forces play a “decisive role.” They’re meant to reduce the amplitude of yuan gyrations without Beijing manipulating market dynamics in ways that irk the International Monetary Fund and Trump’s Treasury Department.
The last thing Xi wants is for the yuan to be the talk of Thursday’s meeting of Group of 20 finance ministers. That gathering will take place on the margins of the IMF’s fall meeting.
Since 2016, the yuan has been in the IMF’s top-five currency basket. That requires China to liberalize the financial system, loosen the capital account and move toward letting markets decide the yuan’s value.
These dynamics, in turn, will get Xi closer to his goal of the yuan rivaling the dollar as a global transactional currency of choice.
A markedly stronger yuan “is not unrealistic in light of the financial market opening in China, the growing cross border capital market integration we see across equities and fixed income, and an increasing proportion of China’s cross-border transactions being denominated in RMB,” says strategist James Lord of Morgan Stanley. “All of this suggests global central banks will need to hold more RMB as part of their reserves.”
It’s a vital part of the reform process. Shifting China’s growth model away from exports once and for all means Beijing must become an importer of capital.
“This,” Lord notes, “means at least $180 billion of net foreign capital inflows per year in 2025-30 are needed to finance the current account deficit.”
4: Thrusting China Inc upmarket
Japan, a far more developed economy, is a cautionary tale of weak exchange rates deadening innovation and productivity. In the short run, a falling currency boosts corporate profits and government coffers. Yet it’s a crutch that stymies economic development in the long run.
Why bother restructuring, inventing new products or shaking up vested interests when government currency managers have your back? This, in a nutshell, is why former Japanese Prime Minister Shinzo Abe’s revival scheme failed to remake an aging and rigid economy.
Rather than modernize operations and make bold changes, executives papered over cracks with weak yen-driven profits. South Korea has often faced a similar complacency dynamic with its giant, coddled, family-owned conglomerates.
On a more basic level, says strategist Timothy Moe of Goldman Sachs, “historical evidence is very, very clear that a strengthening currency is generally supportive for the equity market.”
That could increase the attractiveness of mainland stocks. Xi’s China could do worse than take a page not from Japan, but from Germany.
That high-labor-cost nation has a proven track record of adapting to rising exchange rates. Rather than complain or call for help from government currency managers, German manufacturers use them as a catalyst to disrupt corporate structures, raise productivity and hone competitiveness.
5: Injecting confidence
China’s revival is currency-positive and a rising currency can be a sentiment-enhancing force all of its own.
“A stronger yuan would help China diversify away from the dollar and optimize its resource allocation,” says strategist Wang Ju of HSBC Holdings.
A rising exchange rate is ultimately a show of confidence from abroad. Those capital inflows pull in more long-term investment, lower bond yields, trim inflation and encourage governments to spend more time raising economic games, rather than manipulating markets.
More buoyant capital markets are a precursor to creating more new jobs from the ground up, not protecting state-sector jobs from the top down. This inversion of energy will accelerate China’s transformation into a consumer-driven nation.
Xi can score considerable points in markets as 2021 approaches. Trump is throwing everything he can think of at Asia’s biggest economy – a trade war, a tech war and perhaps a currency war next.
Xi, by sharp contrast, is keeping his eyes on the “Made in China 2025” prize to morph his country into a tech powerhouse.
In Shenzhen on Wednesday, Xi will put more meat on the bones of his designs to transform the city into a “core engine” to drive his Greater Bay Area extravaganza forward. Xi’s Shenzhen address will be as much about the past as it is the future.
Forty years ago, the city became the site of one of Asia’s most important special economic zone experiments. This year, Beijing turbocharged the city’s start-up ChiNext stock market with new Nasdaq-like initial public offering rules.
But the real story is Shenzhen’s central role in propelling China into the decade ahead.
Xi’s new initiatives give officials in Shenzhen greater latitude to utilize local land, hire foreign talent and harness technology, innovation and big data to create Asia’s own Silicon Valley.
It’s a work in progress, of course. Details to date require greater specificity, particularly at a moment when Trump’s White House is actively working to hobble China Inc.
Even so, Xi is signaling that his team is driving China Inc forward at the same moment a rising yuan is providing a tailwind. And letting the globe know that Beijing is confident about where it is steering China into the future.