Gordon Chang on October 5, 2022
China’s central bank has ordered the country’s state banks to stock up on dollars in offshore branches in preparation for a major defense of the renminbi.
Beijing, according to a Sept. 29 Reuters report, will soon be dumping dollars and buying its own currency in markets such as Hong Kong, New York and London.
The yuan, as China’s currency is informally known, has plunged against the greenback, falling almost 14% in onshore markets this year, on track for the biggest drop since 1994 when Beijing forced a devaluation as part of a major reform effort. Both the onshore and offshore yuan — they usually move in tandem — have fallen below the seven-yuan-to-one-dollar psychological barrier.
Almost every analyst in recent weeks has said that Beijing is not concerned about the renminbi’s weakness. The dollar’s surge, after all, is the direct result of the Federal Reserve’s interest rate hikes, meant to stem inflation in America. The dollar has gained ground on every major currency recently.
Analysts correctly point out that the People’s Bank of China, the central bank, pays more attention to the relationship of the yuan with the China Foreign Exchange Trading System’s index of 24 currencies. China’s currency this year has remained relatively steady against this broad-based basket.
The fall of the yuan, a direct result of the Fed’s actions, highlights a key vulnerability of the country: China has remained vulnerable to policy actions in other countries. That means the renminbi is hostage to “hot money” flows.
“For all the talk of the rise of China and the apparent strength of the economy, the Chinese currency has failed to become a safe haven or must-have asset,” Fraser Howie, the co-author of “Red Capitalism: The Fragile Financial Foundation of China’s Extraordinary Rise,” told me. “Capital flows into China while much more open than in years gone by are largely speculative in nature. Stocks remain notoriously volatile and the attraction of Chinese government bonds was not a vote of confidence in China but a yield play based on real yields well above prevailing dollar yields. That time has now passed, and capital is leaving China looking for better returns elsewhere.”
So far, the PBOC, the central bank, has resorted to warnings to traders — “You will lose if you keep betting”— and technical fixes, such as requiring banks to deposit reserves when buying foreign currency through forward contracts.
Nothing has worked, however. And as the Wall Street Journal points out, the “two major factors” that supported the renminbi “look likely to reverse.” The paper argues that exports, the one bright spot in the economy, will decline as consumers in America and Europe pull back. At the same time, Beijing will have to loosen monetary policy to avoid a collapse of the Chinese property sector.
China’s exports in the last couple months have been ailing. That’s bad news for Beijing because China is more dependent on exports than it has been for decades. Net exports of goods and services provided 25% of economic growth in 2020 and 21% last year, the highest percentages since 1997. In the first half of this year, the figure hit 36%. These numbers, even in the best of times, are unsustainable.
China’s crucial property sector, which accounts for at least a quarter of the country’s gross domestic product, is ailing too. The big property developers have been defaulting on bond and other obligations since Evergrande Group went bust last September.
Fundamentals of the sector look awful. In the first half of this year, residential property sales were down 26.6% in terms of floor area and 31.8% in terms of value. New construction permits were off 35.4% in terms of floor area. Land purchases plunged 48.3%.
The sector has eroded since then, and eventually Beijing will have to loosen the money supply further — it is already doing so — to prevent a complete failure. Any loosening will make the yuan even less attractive to hold.
China has bigger problems than declining exports and falling property prices, however. Xi Jinping, set to get his third five-year term as the Communist Party’s general secretary at the 20th National Congress this month, is reembracing Maoism and totalitarian social controls, neither of which have been good for the Chinese economy.
His attack on foreign businesses and domestic private entrepreneurs — both large and small — has had a chilling effect. As a result, companies are either withdrawing from China or reducing Chinese exposure.
If this were not bad enough, Xi’s “dynamic zero-COVID” policy has severely disrupted society and the economy.
“The prerequisite for stabilizing the yuan is stabilizing the economy,” Larry Hu of Macquarie told the WSJ. China cannot stabilize the economy with a Maoist in command.
Many are not worried about the renminbi because of the country’s huge foreign exchange reserves, reported to stand at $3.055 trillion at the end of August. Furthermore, as Goldman Sachs noted late last month, Chinese banks accumulated dollars from “strong inflow pressures” from mid-2020 to 2021, and these assets can be used as “buffers for outflows.”
The confidence in the reserves is misplaced. Beijing almost certainly has been including illiquid stock investments and difficult-to-recover loans as part of its reserves, assets that do not meet the IMF’s definition of includable assets. In short, Chinese officials do not possess enormous “firepower” to battle currency speculators shorting the renminbi.
In any event, past Chinese currency interventions have not worked out particularly well. For example, the central bank burned through roughly $1 trillion of foreign exchange reserves in 2015 defending the currency.
“The big question with such a weak currency in China is will this drive a mass rush of capital outflow as regular middle class investors look to protect their money?” Howie asks. “The Communist Party has been able to control much of the economy because of the strong capital controls ensuring money cannot rush out of China but what happens now when years of strength are being wiped away within a few weeks or months?”
The PBOC will undoubtedly fall back on its last resort: currency controls. The renminbi is not convertible on the capital account and during times of stress it has not been, as a practical matter, freely convertible on the current account either.
So instead of capitulating to market forces, look for Beijing to clamp down hard on outbound money flows when — not if — other tactics fail to stop the yuan from spiraling downward.
Currency controls just buy the Chinese regime time, however. Beijing can censor and misreport news and issue phony economic statistics, but the direction of the currency is almost beyond its control, at least over the longer term.
Gordon G. Chang is the author of The Coming Collapse of China. Follow him on Twitter @GordonGChang.
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