In doing most introductory courses in economics you will have come across the four functions of money which are:
Medium of exchange
Unit of Account
Store of Value
Means of deferred payment
Since the Bretton Woods Agreement in 1944 the US dollar was nominated as the world’s reserve currency and ranks highly compared to other currencies in the above functions. As a medium of exchange the US dollar is very prevalent:
60% of the world’s currency reserves are in US dollars
50% of cross-border interbank claims
After the GFC, purchases of the US dollar increased significantly – store of value.
Around 90% of forex trading involves the US dollar
Approximately 40% of the world’s debt is issued in dollars
In 2018 banks of Germany, France, and the UK held more liabilities in US dollars than in their own domestic currencies.
Is the Yuan challenging the US dollar for reserve currency status? In 2015 Chinese authorities were keen on the currency going global and the following points would indicate this.
Deposits in renminbi = 1trn renminbi = US$144bn
Yuan transactions have grown in Taiwan, Singapore, Hong Kong and London.
Investment by Chinese firms into Belt and Road project = US$3.75bn which was in the renminbi
China settles 15% of its foreign trade in renminbi
France settles 20% of its trade with China in renminbi
The IMF suggest that the ‘yuan bloc’ accounts for 30% of Global GDP – the US$ = 40%
However as reported by the FT – see video below – the goal of reserve currency status was made more complex by the decision to maintain a loose peg to the US dollar. This means that the value of the renminbi would follow the non-specific value of the US dollar. So when the US dollar appreciated so did the renminbi and with a higher exchange rate Chinese exports became more expensive. This led the People’s Bank of China to intervene and devalue the currency by approximately 2% in 2015 – a weaker currency makes exports cheaper.
How do the Peoples Bank of China set the Yuan’s value? Basically at 9.15am the Peoples Bank of China (Central Bank) and the SAFE (State Administration for Foreign Exchange) issues a circular to all the trading banks stating that this is the exchange of the renminbi to the US$ for today.
However this panicked investors who off-loaded their renminbi assets and sent its value downward. The reaction of China was to impose strict capital controls to stabilise the currency. But since the end of 2015 there has been a Chinese foreign exchange policy with the market forces of supply and demand being more prevalent. Nevertheless, there is still a long way to go before the renminbi is a freely floating exchange rate and the benefits that come with it.
I have blogged quite a bit on this topic and refer back to a very good video clip from PBS Newshour on how the Chinese authorities influenced the value of the yuan back in 2010.
Basically at 9.15am the Peoples Bank of China (Central Bank) and the SAFE (State Administration for Foreign Exchange) issues a circular to all the trading banks stating that this is the exchange of the Renminbi to the US$ for today. When companies sell goods overseas the US$ etc that they acquire are then exchanged for Renminbi with the Central Bank – therefore the Central Bank accumulates significant amounts of US$.
Today it could be said that China has done well economically relative to other countries largely due to its large trade surplus. However one would think that with a large trade surplus the yuan would increase in value as there is a greater demand for the currency in order to buy China’s exports. This raises the question as to whether China has been manipulated its currency in order to maintain its competitive edge in the export market.
When a country’s currency is getting too strong the governments/central banks sells its own currency and buys foreign currency – usually US$.
When a country’s currency is getting too weak the governments/central banks sells its foreign currency – usually US$- and buys its own currency.
For two decades until mid-2014 China’s prodigious accumulation of foreign-exchange reserves was the clear by-product of actions to restrain the yuan, as the central bank bought up cash flowing into the country. A sharp drop in reserves in 2015-16 was evidence of its intervention on the other side, propping up the yuan when investors rushed out. Since then, China’s reserves have been uncannily steady. This year they have risen by just 1%. Taken at face value, the central bank seems to have refrained from intervening. That is certainly what it wants to convey, regularly describing supply and demand for the yuan as “basically balanced”. Source: The Economist – “Caveat victor” – October 31st 2020
With the surge in China’s trade surplus the yuan has remained fairly stable and with this you would expect that there would be an increase in foreign exchange reserves with Chinese authorities buying foreign exchange with yuan.
A couple reasons why this may not be the case:
Commercial banks foreign assets have increased by US$125bn since April. The commercial banks are state owned so it is plausible that the government has used them as a substitute. Adding these foreign reserves to the offical figures suggests invention to keep the yuan at an artificially lower rate. There is the possibility that the central bank has special trading accounts at the state banks. Also exporters have wanted to keep their US$ as they are worried that the disharmony with the US could damage the yuan.
The central bank made it cheaper to short the yuan in forward trades – shorting a currency means that the trader believes that the currency will go down compared to another currency.
Chinese officials want the yuan to be volatile but within a narrow range in order to convince other countries that they are not intervening whilst persuading people in the market that they will intervene if necessary.
Caught between a rock and a hard place
The Peoples Bank of China (PBOC) are trying to protect domestic producers by keeping a weak yuan so to make Chinese products attractive to overseas buyers. At the same time they are trying to prevent domestic capital from flowing too quickly out of China to stronger currencies. However a longer term scenario is that China would like the yuan to be more prevalent as a currency in the global market. The yuan currently accounts for approximately 2% of global foreign exchange reserves, although by 2030 it is estimated that it will account for 5% to 10% of global foreign exchange reserve assets.
Source: The Economist – “Caveat victor” – October 31st 2020
Here is a very good explanation from the FT on China’s exchange rate and the fact that the US no longer sees China as a manipulator of its currency – the Renminbi.
In May 2019 with the threat of US tariffs on Chinese goods the Renminbi depreciated in value – notice the chart is inverted which means that 1 US$ buys more Renminbi and the value of the currency falls. To look at it another way it takes more Renminbi to buy 1US$. This makes Chinese exports cheaper in the US.
In August 2019 when the US came good on their threat to impose tariffs the Renminbi fell below 7 Renminbi / US$ in order to protect its exports to the US. Below 7 Renminbi / US$ is seen as a major threshold – the last time this happened was after the GFC.
How do China authorities intervene to manipulate the Renminbi?
The Renminbi is not a floating exchange rate which it is not determined by supply and demand. The government manages its exchange rate in two ways:
Peoples Bank of China (Central Bank) can or sell US$ on the foreign exchange market – this depends on what they wish for the value of the Renminbi against the US dollar
People’s Bank of China permits the Renminbi to trade 2 per cent on either side of a daily midpoint set by the. Basically at 9.15am the Peoples Bank of China and the SAFE (State Administration for Foreign Exchange) issues a circular to all the trading banks stating that this is the exchange of the Renminbi to the US$. It is then permitted to trade 2 per cent on either side of the midpoint rate.
But is China a currency manipulator? According to the US Treasury a country is a currency manipulator when it does the following 3 things:
A significant bilateral trade surplus with the US.
A material current account surplus of more than 3% of GDP.
Persistent one-sided intervention in its currency market.
But in August the Chinese economy was slowing down and the Peoples Bank of China (Central Bank) provided stimulus to the economy which would depreciate the currency anyway. However with more trade talks between the US and China and both agreeing to no more tariffs and phase one of a trade deal, the value of the Renminbi against the dollar starts to appreciate. Although the US has no longer called China a currency manipulator it seems that it didn’t have the grounds to do so. This must be a concern for other trading partners with the US.
A good summary from the FT – see video below. The Renminbi is permitted to trade 2 per cent on either side of a daily midpoint set by the People’s Bank of China (PBOC). This suggests that the PBOC still has significant control of the renminbi. Basically at 9.15am the Peoples Bank of China (Central Bank) and the SAFE (State Administration for Foreign Exchange) issues a circular to all the trading banks stating that this is the exchange of the Renminbi to the US$. It is then permitted to trade 2 per cent on either side of the midpoint rate. The midpoint set by the PBOC on Monday of Rmb 6.9225 was the lowest since December, when trade tensions were last at fever pitch. The PBOC blamed the tariffs and trade protectionist measures on Chinese goods as the reason why the exchange rate has depreciated.
But is China a currency manipulator? According to the US Treasury a country is a currency manipulator when it does the following 3 things
A significant bilateral trade surplus with the US.(Check! China’s got that.)
A material current account surplus of more than 3% of GDP.(China does not have that.)
Persistent one-sided intervention in its currency market.(China’s move on Monday doesn’t fit this bill, so no.)
But isn’t downward pressure on the Renminbi just part of the what happens to a currency when its economy starts to slow and it’s selling fewer exports.
Winners with a cheaper yuan
1. Chinese exporters are more competitive abroad.
2. Foreign consumers of Chinese products – imported products are more affordable.
3. China’s case for becoming a reserve currency could be bolstered by letting markets determine the exchange rate.
Losers 1. Chinese companies that have debt denominated in dollars, or buy things in dollars like Chinese airlines, or other businesses that rely on imported oil. 2. Companies that compete with Chinese firms – including those in neighboring countries. 3. Companies that depend on exports to China – like the makers of luxury goods and mining companies. 4. Anyone worried about weak inflation in the U.S. or Europe
Many thanks to A2 student Emersen Tamura-Paki for this paper on Currency Wars by Fred Bergsten which was delivered in May this year. Although it is a long document it is very readable and contains some interesting points.
* Virtually every major country is looking to keep its currency weak in order to strengthen its eocnomy and save/create jobs.
* Over 20 countries have been intervening in foreign exchange markets to suppress their currency value which has led to the build-up of reserves totaling over US$10 trillion.
* It has been led by China but includes a numer of Asian as well as several oil exporters and European countries. They account for two-thirds of global current account surpluses.
Global surpluses of currency manipulators have increased by $700-900 billion per year – see Figure 1.
* The largest loser is the USA – current account deficits have been $200bn – $500bn per year as a result. Estimate that 1 – 5 million jobs have been lost under the present conditions and likely to continue.
* Japan this year talked down its exchange rate by about 30% against the US$.
* France has called for a weaker euro – which seems the only feasible excape from many more years of stagnation. This favours, in particular, the German economy with its export growth.
However some countries have been justified in their intervention. Some countries currencies have become overvalued and produced external deficits due to widespread manipulation. Brazil and New Zealand are countries which have been justified in their intervention. Our neighbours Australia have also expressed concerns as the appreciation of the AUS$ has been the result of the significant demand for minerals from China. This does leave other exporters struggling to maintain competitiveness especially if their goods/services are elastic in nature.
The systemic problem arrises when there is continued intervention and undervaluation of currencies. Fred Bergsten illustrates the application of these principles in grid where the orange coloured cell constitutes the objectionable behaviour.
According to Bergsten the practice is widespread and the flaw in the entire international financial architecture is its the failure to effectively sanction surplus countries, especially to counter and deter competitive currency policies.
The Business Insider website ran a story about a currency manipulator that is bigger than China. They are referring to Israel whose holdings of foreign currency is 61% of GDP compared to 45% in China. The chart below shows the Bank of Israel’s (BoI) foreign currency reserves, which have ballooned since early 2008 when the central bank began buying up dollars and selling shekels. By selling shekels and buying US dollars the Bank of Israel hopes to make its exports more competitive by maintaining a weaker currency. March 2008 was he first time since 1997 that the Bank intervened in the foreign exchange market. However markets are of the opinion that the BoI run a dirty float policy on the exchange rate and speculate as to what its intervention price is. Some suggest that the price that they are aiming for is approximately 3.8 shekels per dollar.
Although this is an interesting article I do wonder how a small economy like Israel’s can be of any serious threat to the US manufacturing sector. Also I would suggest that reserves of 61% of GDP in Israel is a lot smaller than 45% of GDP in China. The actual figures are below:
However, all this accusation of the US calling China a currency manipulator is interesting when you consider other countries e.g. Israel and Switzerland are doing something similar. For the US, having a trade deficit is a function of it simply consuming beyond its means. The exchange rate matters with which country you incur the trade deficit with. If China’s goods became more expensive (with the Yuan allowed to appreciate) the US would probably keep on borrowing more money. From a Chinese perspective why should it have to stop fixing its exchange rate to the US$ when the US keeps on borrowing money and getting into further debt.
After Bollard’s indication yesterday that inflationary pressures were mounting and there would be a tightening of monetary policy of over 2%, the NZ$ reached the milestone of US$0.83 cents. The main reasons for its rise over the last few months are twofold:
1. The weak US economy
2. Global commodity prices for exports including dairy
Below is graph from the BNZ outlining the NZ$ movement during May.
One wonders where the NZ$ will go from here. The BNZ have put together a couple of key NZD risk scenarios:
Scenario 1: The NZ good news continues: NZD/USD rises above 0.8500
Under this scenario, the NZ economic recovery continues to gather steam, and NZ commodity export prices hold up around current record highs, or press even higher. Against a backdrop of recovering economic growth, the RBNZ is forced to respond to rising capacity and inflation pressures and hike rates aggressively. At the same time, the building signs of a US economic slowdown become entrenched and the Federal Reserve is forced to maintain extremely loose monetary policy for even longer than markets currently expect.
Scenario 2: The US bounces back: NZD/USD falls below 0.7500
History tells us peaks in NZD/USD are almost always preceded by a bottoming in the USD. While there’s no doubt the US economy is down and out in the here and now, analysts still expect US growth to build to around 3% by year end. Given this, we are cognisant of the significant upside potential in US bond yields. A material sell-off in US bond markets would reverse the downtrend in US interest rate differentials, contributing to a sustained rally in the USD. Not only would this contribute to a lower NZD/USD directly, but a firmer USD would also knock commodity prices lower, compounding the downward pressure on the NZD.
There has been talk in the media of intervention by the RBNZ in the foreign exchange market to reduce the value of the NZ$ and therefore make our exports more competitive. However will that ultimately work? Official intervention means that the Reserve Bank buys or sells foreign currency in an attempt to influence the exchange rate value. Buying foreign currency with NZ dollars is intended to push down the value of the NZ dollar whilst buying NZ dollars with foreign currency has the reverse effect.
A previous attempt by the RBNZ to weaken the NZ dollar happened in June 2007. This action didn’t work and what was ironic about it was that the intervention took place a few days after interest rates were increased to 8% – this seems inconsistent with what the RBNZ were trying to achieve as higher interest rates usually strengthen a currency’s value. See graph below: