China’s Conundrum: The Dilemma of Holding the Yuan Steady
China’s Stability Concerns
China’s seeming determination to hold the yuan stable in the face of a deflationary asset price bust and capital flight leaves it with an unenviable conundrum familiar in past property crises around the world.
The Yuan’s Stability
Does it hold the currency steady to prevent a further run on foreign investor confidence? Or should it entertain another export-boosting yuan depreciation as an alternative to the ‘internal devaluation’ of falling domestic consumer and asset prices already crimping growth?
Government’s Stance
For now, as government officials publicly state almost daily, it continues to opt for a basically stable exchange rate.
Market Impact
And curiously, the still tightly controlled yuan held firm this week even as authorities moved to ease monetary policy once again to stabilise another alarming lurch lower in China stocks.
Proactive Policies
For some, the fact that Beijing may be at last ratcheting up piecemeal policy supports to date may be enough of a confidence boost to buoy the currency despite the prospect of lower interest rates.
Global Economic Factors
What’s more, expectations of U.S. and European interest rate cuts later this year may also allow China some currency wiggle room – unlike last year when the yuan fell 8% as Chinese rates were cut while western central banks tightened.
Foreign Investor Confidence
But the “sentiment channel” may have to work hard to convince foreign investors – many of whom have removed most all direct exposure to China’s markets as they await next steps and try to figure out Beijing’s priorities.
China’s Economic Situation
China finds itself on the other side of the boom years of rapid growth and a productivity boom, nursing a popped credit-fuelled property bubble, slowing growth and falling prices.
Domestic and External Investment
U.S. corporate, banking and portfolio money is exiting – rattled by geopolitical rifts, bilateral investment curbs, fractured world trade patterns and also a population decline that’s sapping future growth potential.
Monetary Easing
This week’s monetary easing via reserve requirement cuts likely tees up more official interest rate cuts ahead – with the 160 basis point yield premium on U.S. Treasuries bonds widening anew.
Policy Evaluation
“Slow, reactive and insufficient” was how Morgan Stanley analysts described official policy supports before this week.
Yuan Stability Concerns
Shoring up the yuan is at the root of much of the hesitation.
Policy Challenges
And several reasons are cited for reluctance to pull the currency lever.
Economic History
For analysts at CrossBorder Capital, the dilemma is simply all too familiar with property busts of yesteryear – not least Japan’s in the 1980s/1990s, southeast Asia in the late 1990s and even in the United States in 1920s/1930s.
The Author’s View
“China is suffering the aftermath of an asset bubble resulting from a misaligned ‘real’ exchange rate,” they wrote.
