China: Monetary Meddlers?

One of Donald Trump’s latest eyebrow-raisers has been his conflicting statements about Chinese currency manipulation, or the lack thereof. This is yet another rehashing of an issue which has been debated since at least the Bush Administration, always loaded with implications for trade policy and the relative strength of particular industries.

There’s an element of truth to Donald Trump’s original stance – in the early 20-aughts, the Chinese government certainly engaged in currency intervention to manipulate the balance of trade with partners like the U.S., strengthening Chinese export prospects and, according to some, speeding the demise of American manufacturing. Trump’s lunch with Xi Jinping seems to have updated him on the state of affairs, though – for the last several years the situation has been more complicated, and in many ways the opposite.

Some background may be in order. The swirl of commentary surrounding the situation has entailed plenty of discussion about what exactly currency manipulation is and how it affects the economy, a set of facts Americans are perennially reminded as it occasionally enters political punditry. So for those who aren’t familiar, a refresher:

Currency, like all goods, follows the laws of supply and demand, so if there’s a larger supply of money in circulation each unit is worth less. A government so inclined can use this fact to deliberately influence exchange rates. The Chinese government, for instance, began in the mid-90’s to take Chinese yuan out of their treasury vault, buy US dollars with them, and stow the dollars away, effectively increasing the supply of yuan relative to dollars and keeping the price of the yuan low. A government’s motives to do this might include influencing inflation or exports. In China’s case, a devalued yuan ensured that Chinese goods were artificially cheaper abroad, strengthening the Chinese export market.

The effects of China’s currency intervention have been mixed. Chinese exports as a proportion of GDP peaked in 2006, since when the government has stopped restraining the yuan so aggressively and the exchange rate has moved from the 8.3 where it stood for ten years. Since 2014, in fact, the yuan has made an about face and is losing value against the dollar, and the government has been buying currency back and propping up state-owned companies to try to slow the descent of the yuan and prevent runaway inflation and acute trauma to the Chinese economy.

The historical relationship between CNY and USD

The reasons for this have been various. Fundamentally, the devaluation of the yuan has imbalanced the Chinese economy. Tipping the balance towards exports has made importing into China more costly, stunting industries that rely on imports and slowing the development of a consumer market. Also, as manufacturing workers demand higher wages, the industry has moved towards automation.

The upshot of all this is manifold. Continuing inflation makes the market very attractive for lenders, filling the market with capital and raising the danger of creating bubbles. Meanwhile, slowing the descent of the Chinese economy is burdening the government with ever more debt. On the whole, the Chinese economy, for a long time a seeming miracle, seems to be recalibrating with reality. The silver lining in this situation is that consumer confidence and demand for more premium consumer goods continues to grow as living standards broadly rise in China.

Companies that are able to tap into the pent-up demand in China for consumer and foreign goods while avoiding overvaluation are the potential winners. While it’s not clear yet who’s going to emerge in that role, it’s likely that they will come from within China unless fiscal regulations change significantly.

More to come.


UPDATE: We have identified the Chinese gaming company Changyou as having a high potential for growth and recommend investing.

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