The currency is at its lowest level against the dollar since the 2008 crash
In the midst of a rapidly changing global economic order, it can be difficult to separate the signal from the noise. We are simultaneously informed of China’s imminent collapse, the end of the US Dollar and US hegemony, how a new multipolar world order is emerging, and that Europe is descending into irrelevancy. Doom and gloom is back in fashion, but is it justified?
While the end of the world might not be imminent, there are some worrying trends. China, for example, is facing very tough economic decisions — highlighted by the current troubles of its currency, which, it was reported this week, is at its lowest level against the dollar since the 2008 financial crash.
The Federal Reserve’s interest rate policy has been putting enormous pressure on the yuan, with two-year US Treasuries yielding close to three percentage points more than their Chinese equivalent, making American debt more attractive. A consequence of this is a weakened yuan versus a stronger dollar, because there is higher demand to hold US assets in the expectation of higher returns.
The initial reaction to this might be that a weaker Chinese currency would strengthen exports, something that Beijing’s leadership should welcome. Alas, that is only half the story. A weaker yuan might be good for exporters, but it would negatively affect domestic consumption. The Chinese have a notoriously low domestic consumption, with only a 37% share of consumer spending as part of GDP. For comparison, it is 68.1% in the US, 56.3% in the EU, 51.9% in Russia, and 59.6% in fellow Brics member India.
This matters, because in an era of global re-shoring and American determination to re-industrialise (successfully so, if one looks at the boom in manufacturing facilities construction), future Chinese growth must be driven by national demand. The decades-long successful policy of export-led growth is ending, but at this point China’s national economy cannot absorb the loss of foreign markets.
There are psychological factors at play, too. A continuously weakening yuan could become a symbol for other structural issues in the Chinese economy, like the fact that private debt is three times its GDP, the flight of foreign investors from the Chinese stock market, or a youth unemployment rate of over 20%.
In many ways, China has responded in exactly the manner expected of an authoritarian regime. Just stop publishing data and pretend everything is fine. Unfortunately, all is not well, and Beijing remains trapped between a rock and a hard place. Printing more money and creating domestic stimulus is a tempting option, but it comes at the risk of an even weaker currency that not even Chinese people are particularly keen on holding.
This is why Beijing enforces strict capital controls, meaning one cannot easily move and exchange Chinese money internationally. Estimates assume that a fully liberalised capital account would cause over 20% of household savings to be diversified out of China.
The other option would be for the People’s Bank of China to strengthen the yuan, but this would also mean higher interest rates and less money in circulation, putting pressure on already heavily indebted borrowers and weakening China’s competitiveness as an export nation. Economic growth would only slow further.
While China is hardly on the brink of an immediate economic collapse, it is going through the largest transformation of its economy since the 1970s. As Britain’s Foreign Secretary, James Cleverly, reminds us, disengaging with China is not a viable option. So it will be interesting, beyond economics, to track what the political consequences of this shift might be.