In 2016, the International Monetary Fund (IMF) added Chinese RMB to its special drawing rights (SDR) basket. The RMB joined an elite class of currencies which included the U.S. Dollar (USD), Euro, British Pound, and Japanese Yen to be safe, reliable and freely usable. IMF’s move may have raised many eye brows, as the Chinese RMB does not meet the criteria of being freely usable or widely tradeable currency in financial markets; It certainly did catch the attention of then U.S. Presidential candidate, Donald trump. He, after listening the news had said he would label China as a currency manipulator if he wins.
Lo and behold! Donald Trump did win the elections and he has since labelled China as a currency manipulator on every possible occasion since taking charge of the country. Every time when the RMB was in decline against the USD, many expected Trump to blow it out of proportion. While it is not always right to blame China as a currency manipulator, China Knowledge will attempt to list the reasons China’s RMB is so closely watched by the world in general. This article is an attempt to explains the mechanism for a currency’s appreciation and depreciation and how U.S. itself is contributing in RMB’s rise and fall.
Foreign exchange is the price for currencies, it sets the price of one currency against another currency or against a basket of currencies. Currency, like many other commodities, is governed by the laws of supply and demand. A rise in demand or fall in supply, of one’s currency, would lead to that currency appreciation. The same works vice-versa when there is a fall in demand or an increase in supply it would lead to that currency’s depreciation.
In an ideal situation, when one’s money is strong, that country is able to purchase more of another nation’s currency, subsequently, which means buying more goods and services of that country. When one country has a trade surplus (current account surplus) mainly from exports, it can expect its currency to have an upward appreciation pressure, as other countries will have to pay for the imports using the host’s currency in exchange of their own.
Currency manipulation is the attempt to avoid the negative consequences of a strong currency. When a country’s currency is too strong, for example U.S. dollar, other countries find it difficult to buy that country’s exports, hence hurting exports.
Washington is constantly on China’s tail as the former strongly views Beijing doing currency manipulation at the expense of U.S. Its argument is that because of China undervaluing the RMB, it is killing jobs in America. It accuses China of using foreign exchange reserves to purchase other currencies, such as the USD to keep the RMB artificially low.
In China, it is expected that the currency will be in high demand as the country offers several products and exports. It is also true that, China has a positive trade surplus and other countries will need RMB.
There are many factors behind RMB’s depreciation, many of which are beyond the control of China. The U.S. herself contributes to the depreciation of RMB but does not explicitly make it known for the average person to understand.
First of all, when the Federal Reserve raised interest rates, just as the third time this year, it made USD stronger. It is because, in simple words, the FED’s interest rate is the benchmark rate for many other interest rates in the U.S. an increase would affect investors and consumers in the country’s economy, especially foreign investors. That is because foreign investors like the carry-traders will invest into U.S. treasuries or U.S. bonds, thereby making the USD stronger and other currencies, like the RMB weaker. Many expect the FED to increase interest rates for one more time by the end of this year.
U.S. Treasury released a semi-annual report on exchange rate policy, yesterday, which argues that the major U.S. trading partners, including China, have not manipulated the currency exchange rate. Hence, there is no solid evidence of President Trump saying China is a currency manipulator.
Second, investors’ sentiments in the world still favor the USD in the face of uncertainty. Each time when the world economy enters into unpredictability, the USD is still the choice for all investors. This, in fact, makes the USD appreciate against all other currencies, the RMB would also be seen to be depreciate from “currency manipulation” when in fact it was a century old move by investors because of the unique environment by the U.S.
Third, while major goods like oil are being imported in the U.S., according to Energy Information Administration, the U.S. is a net importer of oil at 3.77 million barrels per day. As oil prices spiked in early October, to counter the price increase, it was only natural to expect congress to make laws that led to or favored the USD to appreciate. Such laws can be seen when President Donald Trump announced tax cuts which would lead to the widening of the fiscal deficit, thus government borrowings, resulting in greater inflation and would need the FED to hike interest rates. It is like the product of the U.S. own doing.
The depreciation of RMB in the recent period may reflect weaker China financial market. In China this year, it has seen a bearish stock market coupled with peer-to-peer payment platform failures, fueled by an ongoing trade-war triggered by President Trump and a scandal in Saudi Arabia, all these events take a toll on the RMB.
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