There’s a strong case for a weaker yuan
As talk pivots from decoupling to recoupling, a US-China exchange rate accord could work to mutual advantage
TOKYO – Some good news for a change: The coming decline in China’s currency is just what President Xi Jinping’s economy and the global financial system need.
It’s enough to make Donald Trump’s head explode, but a weaker yuan would be a welcome development in Washington. As much as US officials abhor weak Asian exchange rates, they are very keen to steady a wobbly dollar.
China’s exchange rate about-face will be less about manipulation and more about the People’s Bank of China and the Federal Reserve pivoting in divergent directions. The PBOC will be easing, of course, to avoid a deeper property market slump. And the Fed needs to start hiking interest rates to tame surging consumer prices.
There’s no indication that Xi and US President Joe Biden discussed currencies in their virtual summit on Tuesday. But it’s a safe bet that top Chinese and US officials are swapping views on inflation risks behind the scenes.
Pressures bearing down on the US are increasingly troubling. Not just because the 6.2% year-on-year rise in consumer prices in October was the biggest in 31 years. What is especially unnerving is how rapidly higher factory costs passed down to finished goods prices.
Across the Pacific, things look less dire.
China’s modest macro problem
China’s inflation worries are still at the factory phase of the product cycle. Its October consumer price index rose a tamer 1.5%. This suggests the PBOC has the latitude to ease credit conditions without significantly fanning inflation. It also helps explain why China-region stocks are staging a comeback as 2021 wraps up.
Granted, the default drama at China Evergrande Group, Fantasia Holdings and other property developers has global markets on edge. The pressure on that sector is partly the result of regulatory crackdowns on leverage in the financial system. An industry that generates one-third of gross domestic product (GDP) is in growing need of support.
Containers are stacked at a port in Qingdao in China’s eastern Shandong province. The Chinese and US economies are highly interdependent. Photo: AFP / StringerThe “urgent question is whether the constraints on lending to property developers have eased,” says Xiaoxi Zhang at Gavekal Research.
The reason: the tightening of developers’ access to credit has been unprecedented, Zhang says. Loans slowed to 0% year-on-year in the July-September quarter from 2.8% growth in the second quarter and 4.5% in the first. Over the past decade for which data is available, Zhang says developers’ loan growth had never fallen below 5%.
Credit data for October don’t hint at improvement. Medium to long-term loans to non-financial companies increased $34 billion, the smallest gain since late 2018. Since lending to developers isn’t likely to crowd out other corporate lending, the low figure suggests there hasn’t been much acceleration.
“It would be rational for banks to see lending to property developers as risky right now, so they may be unwilling to lend more even if permitted to do so,” Zhang says.
Last month, Beijing regulators hinted at providing funding support. That modest relaxation of mortgage lending terms won’t be enough to prevent further stress on already cash-strapped developers.
The Beike Research Institute argues that average mortgage rates across 90 major cities only slid by 0.01 percentage points in October. Even if this is the first monthly drop this year, it’s too minor to influence real-estate demand.
A lower yuan exchange rate, a product of looser PBOC policies, is just what Xi’s economy needs heading into 2022.
“We think the main reason for the recent strengthening of the renminbi lies in China’s better-than-expected export data,” says analyst Zhang Jundong at China International Capital Corporation.
The default drama at China Evergrande Group has global markets on edge. Photo: AFP / Peter Parks“However,” he adds, “US domestic demand for goods may gradually weaken after the end of fiscal subsidies. As such, we think it is difficult for China to maintain a high level of trade surplus, and thus the renminbi is unlikely to strengthen substantially.”
Analysts at Fitch Solutions are in accord. Their argument: “The yuan remains overvalued, which could weigh on the currency.” They point out that the real effective exchange rate, or REER, is 4.6% above its 10-year moving average as of September, compared to 4.2% in June.
This, Fitch says, “will limit the potential for yuan appreciation over the coming quarters.”
At the same time, Fitch says, “the balance of risks to our forecast is tilted to the downside, mainly emanating from the contagion risk in China’s real estate sector.”
As such, a softer yuan as 2022 unfolds is the most likely scenario.
New era Plaza Accord?
Even better if Xi and Biden made things official and agree to a formal exchange-rate truce. Getting there, though, requires cleaning up the default troubles shaking confidence in China Inc.
It’s here where looser monetary policy would come in handy. And that’s going to require official direction from the highest levels.
Analyst Ju Wang at HSBC says that while the yuan exchange rate is somewhat “protected” by the Chinese trade surplus, its strength probably won’t continue because of Xi’s deleveraging policies.
Jake Sullivan raised the possibility of a currency pact with China. Photo: AFP / Yasin Ozturk / Anadolu AgencyOne way to save the dollar and support China’s reforms is to strike a currency deal between the Group of Two – a new “Plaza Accord,” perhaps.
The reference here is to the 1985 pact at the Plaza Hotel in New York between the two then-biggest industrial powers to strengthen the yen. Since that, Beijing has replaced Tokyo in Washington’s crosshairs as the Pacific economy of concern, particularly during the 2017-2020 Trump era.
This idea of bilateral currency amity is not simply your correspondent’s.
In January, Jake Sullivan, Biden’s National Security Advisor, reportedly raised this very possibility in a Wall Street Journal interview. He cited the 1985 deal as a good template for Sino-US economic and trade relations.
It could be a face-saving solution for Biden and Xi – two men who want to avoid looking too willing to compromise on the world stage. What’s more, it would be a first constructive move toward “recoupling” after the last few years of decoupling fever.
Since Trump’s White House stint began, the economic zeitgeist has leaned toward decoupling, pushing any constructive efforts to cooperate to the sidelines.
Yet all available data demonstrate a continued high degree of codependency. Even for pros, it’s hard to find where the US economy ends and China’s begins.
“Leaders in both countries remain concerned about the potential for that interdependence to be weaponized,” says economist Zack Cooper at the American Enterprise Institute. “The Biden administration has therefore stressed the need to secure supply chains, while Beijing has talked about ‘dual circulation,’ which would reduce its own dependence on foreign markets.”
Wang Qishan with Xi Jinping. Wang says China and the US must cooperate to boost global economic growth. Photo:One of the “best, and most overlooked, ways to lessen China’s leverage is, counterintuitively, deeper coupling in certain areas,” Cooper argues. “In other words, Washington should be playing offense, too, not just defense. Making China more dependent on the US should be part of any strategic approach toward Beijing.”
This week, Chinese Vice President Wang Qishan told Bloomberg that Beijing and Washington must cooperate to boost global economic growth.
“China cannot develop in isolation of the world and nor can the world develop without China,” Wang said. “China will not waver in its resolve to deepen reform and expand opening up.”
In recent months, US Trade Representative Katherine Tai has pledged “to chart a new course to change the trajectory of our bilateral trade dynamic.” That has many investors figuring the Biden White House will increase engagement with Chinese trade.
The first step, of course, would be scrapping Trump’s tariffs on Chinese goods.
Those taxes backfired. They did zero to narrow the China-US trade deficit but cost Washington considerable soft power in geopolitical circles, while also adding to US inflation pressures.
What better way is there for Biden to reduce the risk that Xi’s men might retaliate further, leading to Trade War 2.0?
After all, Xi has any number of ways to make Biden’s life difficult.
China could retaliate against the US by enforcing an Airbus-only policy. Credit: Airbus.He could limit or ban US car sales in China or impose an Airbus-only policy on airlines and transport companies. China could tax workers employed in the mainland by American companies.
It could complicate life for Apple, Exxon Mobil, the Gap, General Electric, JP Morgan Chase, McDonald’s, Nike, Tesla and Wal-Mart with new levies or regulatory hoops to jump through.
And Beijing could always threaten to sell its $1.1 trillion of US Treasury securities. From time to time, state-run news outlets drop hints that such a move is under consideration.
No question, there would be an element of MAD – mutually assured destruction – if that policy were enacted. Any jump in US rates would shake markets and send tsunamis of turmoil China’s way, too.
All the more reason for Biden and Xi to kick start the China-US healing process with cooperation on exchange rates. As win-wins go for China and the US, this one seems a no-brainer for the G2 in 2022.