Dollar strength has generated tensions in global currency markets. This is especially challenging for Chinese authorities facing downward renminbi pressure given diverging US-China monetary policy stances, home-grown economic headwinds and the history of US-China currency market strains.
In view of these developments, China should avoid renminbi depreciation against the dollar. US authorities should acknowledge that the renminbi pressures are in large part driven by dollar strength, keep the focus on China addressing its growth model and overcapacity and push back on any renewed currency tensions.
The dollar has been very strong in recent years (Figure 1). Generalised dollar strength primarily reflects Federal Reserve hikes and rising US yields over the past two years. But the dollar has also been buoyed by solid growth at a time when others faced weakness, expansive fiscal policies and geopolitical turmoil often resulting in a resurgence of risk-off sentiment.
Figure 1. The dollar has been strong in the last few years
Real dollar: broad monthly
Source: Federal Reserve
In contrast, China faces deflationary pressures. Consumer sentiment is weak, reflecting housing woes and low confidence. The authorities have resisted providing strong fiscal support, especially for consumers. Meanwhile, Chinese yields have fallen (Figure 2).
Since early 2022, US 10-year yields have risen around 2.7 percentage points to 4.5%, while Chinese yields have fallen nearly 50 basis points to 2.3%, a differential of almost 2.25%.
Figure 2. Chinese yields have fallen drastically
Chinese and US 10-year bond spread
Source: World Government Bonds
Renminbi downward pressure might seem surprising. China runs a hefty current account surplus in the 1% to 2% of gross domestic product range. The trade surplus is 3% to 4% of GDP and the manufacturing trade surplus more than 10% of GDP. For an $18tn economy representing over 15% of global GDP, those are ginormous surpluses.
Nevertheless, downward pressures are real, as George Magnus of the University of Oxford’s China Centre points out. Many exporters are reportedly not converting earnings into renminbi. Due to the interest differentials and low confidence, large capital outflow pressures are evident.
Moreover, burned into the psyches of Chinese leaders is the 2015-16 experience when depreciation against the dollar snowballed into a massive capital exodus, which the People’s Bank of China was only able to slow – despite deploying its entire playbook – through dollar sales of $1tn.
Figure 3. Stability against the dollar has caused trade-weighted renminbi appreciation
Renminbi to dollar spot exchange rate
Source: Federal Reserve
Facing these developments, China has sought to keep the renminbi steady against the dollar, especially this year. Though official reserves are reportedly little changed, the authorities have used daily fixings, state-owned commercial bank activities and other forms of administrative guidance to clearly signal that renminbi depreciation versus the dollar is not desired.
Stability against the dollar has meant some real appreciation on a trade-weighted basis (Figure 3). But again, the renminbi seems extremely competitive (Figure 4).
The US for its part has long supported greater market-orientation in the renminbi. However, that was essentially code for supporting renminbi appreciation (or avoiding depreciation) against the dollar.
Figure 4. Renminbi remains competitive
%
Source: China Foreign Exchange Trade System
Renminbi developments have long generated currency tensions with the US, especially in 2004-14 given large Chinese current account surpluses, massive reserve accumulation and the enormous bilateral trade surplus with America. During that period, strong protectionist pressures emerged in the US alongside calls to declare China a currency ‘manipulator’ and slap import duties and other restrictions on Chinese goods.
These tensions resurfaced during the Donald Trump presidency given deteriorating US-China relations and dollar appreciation, even though the latter was more a reflection of US rate increases, expanding deficits due to the Trump tax cuts and the administration’s tariffs on China that market participants viewed as making Chinese exports less competitive.
Currency tensions with China have been muted, however, in the Joe Biden administration. China’s current account surpluses are below the Treasury’s threshold for finding manipulation and its reserve growth has been essentially flat. The administration understands that the downward pressure on the renminbi is in part a reflection of generalised dollar strength.
The Treasury has instead correctly sought to focus on the underlying determinants of China’s external surpluses – namely, large support for a state-led investment driven growth model, mirrored in low consumption as well as in production not absorbed at home pouring onto global markets. Further, US Treasury-Chinese financial authorities have opened an economic and financial dialogue, welcomed by both countries, aimed at helping steady the fraught bilateral relationship.
Where does this leave the US and China in the face of potential renminbi depreciation?
China has enough economic headaches against the US now with chips, electric vehicles and tariffs, especially as the presidential elections unfold. It should be wary of further US countermeasures or protectionist pressures that might be spawned by renminbi depreciation. The renminbi is extremely competitive. China surely doesn’t want to run the risk of another 2015-16 capital exodus. Thus, China should continue to strongly resist renminbi depreciation and at least keep the currency stable against the dollar.
The US for its part knows that dollar appreciation versus the renminbi is significantly a dollar story and that the divergence in US-Chinese monetary policy stances may ease – and with that downward pressure on the renminbi – in the period ahead if US demand and inflation pressures cool. It should keep its focus on China’s growth model and excess capacity, even if there is little short-term relief on these issues.
Mark Sobel is US Chair of OMFIF.
