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Beijing mouthpieces like China Daily are working overtime to warn yuan bulls not to take this year’s rally too far. A case in point was a headline this week declaring that the “Rapid Rise of the Yuan Is Unsustainable.”
Fair enough. But to what extent is the yuan surging toward 6 to the dollar really President Xi Jinping’s call?
Academics like Sheng Songcheng, former head of statistics and analysis at the People’s Bank of China, appear deputized from on high to get the word out. Sheng and other surrogates are throwing cold water on a key theory why Xi might tolerate a rising yuan: inflation.
“The appreciation of the renminbi against the US dollar cannot be used as an instrument to counteract the effects of commodity price increases,” Sheng says.
But then how many instruments does Xi have to tame optimism in the yuan as investors everywhere sense China’s currency has reached an inflection point? A number, of course. The yuan, remember, still isn’t fully convertible. The capital account remains decidedly rigid. Nor do speculators tend to succeed betting against the PBOC and Beijing regulators.
Even so, upward pressure on the yuan is intensifying as China leads post-Covid-19 recoveries, the dollar stumbles and overseas channels into mainland stock and bond markets widen.
Eric Robertsen, global head of research at Standard Chartered, notes that most investors think Xi’s government won’t let the yuan get anywhere near 6 to the dollar. “It’s our view,” Robertsen says, “that there is potential for that narrative to change as China becomes more domestically focused or in a world in which commodity prices are rallying a stronger RMB might preserve their purchasing power.”
All this argues in favor Xi standing back and letting the yuan move toward 6 from 6.38% now. Here are three reasons why.
An image makeover
One: boosting Asian will buttress Bejing’s soft power. With China seen growing as much as 8% this year, Xi’s government has a timely opportunity to score some points with a region unnerved by its bullying ways.
On Monday, Xi took the unusual step of urging Communist Party bigwigs to create a “trustworthy, lovable and respectable” image globally. It was the clearest sign yet that Xi realizes the need to tamp down a “wolf warrior” ethos backfiring spectacularly.
Xinhua reports that Xi called on Beijing to “make friends extensively, unite the majority and continuously expand its circle of friends with those who understand and are friendly to China.” The nation, Xi said, must get “a grip on tone” on global relations and “be open and confident, but also modest and humble.”
Tall tasks for a government that spent the last year overreacting – almost everywhere. Team Xi had a fit over Australia calling for an investigation into the origins of the coronavirus. China’s trade treaty with Brussels hit a wall as Beijing threw a tantrum over Europe’s concerns about policies toward Uighur Muslims in the western Xinjiang region.
Officials from India to Japan to South Korea to Southeast Asia have their own stories to tell about China being anything but loveable.
A stronger exchange rate that boosts purchasing power would earn China huge points around the globe. Just as a rising dollar did for America’s global standing amid the 1997-1998 Asian financial crisis. Back then, Federal Reserve Chairman Alan Greenspan called the US an “oasis of prosperity.” China assuming that role in 2021 could pay huge dividends for years to come.
Two: arming China Inc with new firepower. Xi’s “Made in China 2025” program is about creating a more innovative and vibrant services sector. But the rising yuan also makes established overseas corporate giants more affordable.
Which country doesn’t want to leapfrog over years of painstaking domestic industry building? Creating powerhouses indigenously takes years of hard work and nurturing. Here, think of Lenovo’s 2004 purchase of IBM’s computer business. Or the rationale behind Ant Group’s 2018 attempt to acquire US money transfer company MoneyGram International.
A buying spree?
A surging yuan makes Apple, Boeing, Citigroup, General Motors, Microsoft, Nike, Tesla and United Airlines cheaper for acquisitive mainlanders. Why fear Google, Facebook and Snapchat when you can just buy and propagandize them?
Why bother developing a domestic answer to Starbucks when a surging yuan makes the Seattle-based behemoth cheaper by the month? Why do the regulatory heavy lifting to build a Chinese Goldman Sachs when Wall Street icons are there for the taking? China’s state-owned banks are plenty huge, but none generates the global buzz of US, UK and European names.
Beijing could take its $3.2 trillion of foreign currency reserves out for a ride to pick up key semiconductor manufacturers around the globe. Would lawmakers try to scuttle such acquisitions, as we’ve seen from Washington to Canberra? Absolutely.
But governments that claim to champion capitalism can’t knock back every takeover attempt fueled by a rising yuan. For lawmakers around the globe calling for a stronger yuan, China Inc’s fast-rising purchasing power, fused with the government’s global ambitions, makes this a be-careful-what-you-wish-for moment.
Three: a rising yuan heads off all manner of troubles. No good would come from a seriously overvalued yuan setting China back the way a yen surge did Japan in the late 1980s. But an orderly advance could tame the inflation pressures that have to be spooking Xi’s inner circle.
Though academics like PBOC alum Sheng deny it, surging price pressures are the last thing Asia’s biggest economy needs. So, why fight a rising yuan?
“We believe that the USD-RMB will be more two-way this year, as China’s cyclical advantage narrows while the rest of the world catches up, with greater availability of vaccinations and economic re-openings,” says currency strategist Wang Jun at HSBC.
But, as analysts at HSBC and peers note, those re-openings may cause a combination of both cost-push and demand-pull inflation at the worst possible moment for the global economy.
The former can be seen in surging commodity prices. The 6.8% jump in mainland producer prices on April year-on-year has thankfully not filtered through to consumer prices, which are up a mild 0.9%. A rising yuan would continue to shield households from destabilizing price surges.
Xi may find, as China leads the pack post-Covid-19, growth is more likely to surprise to the upside than the downside.
“One should not forget that the reopening in the Western world is a new positive factor for the Chinese economy,” says strategist Nadège Dufossé at global asset manager Candriam Investors Group. “A positive feedback loop is developing here, leaving industrial China a winner.”
Dufossé points to a clear uptick in China’s manufacturing Caixin purchasing managers index to a new high for 2021, which “reflects both the global recovery and ongoing domestic demand.” She expects both developments to continue, if increases in both domestic and export order components are any guide.
“Clearly,” Dufossé says, “the recent recovery has been supported by significant monetary and fiscal accommodation in the Western world and, of course, vaccine success. Chinese exporters, still the prime global supplier in many areas of the industrial sector, are producing to fill surging post-Covid orders.”
This is validated by the so-called Li Keqiang Index, named after China’s current premier. The gauge is currently the highest since Xi and Li took power in 2012 on the strength of heady freight volume, electricity consumption and growth in total loans.
“The ongoing strength of the Chinese economy is supportive of its stock market,” Dufossé says. “In particular, we are maintaining our positive view on the supply chain rebuild and infrastructure – both traditional and green infrastructure – in the industrial sector.”
There are myriad other considerations at play here. One is that any visible attempt to weaken the yuan, or cap its gains could create new tensions with Washington. It might put pressure on President Joe Biden to leave his predecessor’s tariffs in place.
Another is sending the right message. A rising exchange rate is a sign of strength. On the one hand, it’s a vote of collective global confidence. It pulls in foreign capital, reduces bond yields, solidifies government and corporate balance sheets and makes overseas debt easier to service.
On the other, it suggests Xi is confident enough in his political standing and China’s underlying financial system to let market forces take the lead.
The yuan rising to 6 and beyond is not inevitable, but it could be an unmitigated plus for Xi’s China.