34 BARRON’S October 19, 2020
THE ECONOMY
The Chinese yuan hasn’t moved 4% up or down
since 2017 by one key metric. One economist
believes the yuan isroughly 10% undervalued.
Behind Yuan Stability:
Beijing’s Hidden Hand
C
hina’s yuan has
been remarkably
stable over the
past few years,
almost as if it were
being manipulated
by the govern-
ment. But the U.S. removed its desig-
nation of China as a currency manipu-
lator earlier this year, and you won’t
find Beijing’s fingerprints on the scale
here—not directly, at least.
Since the beginning of 2017, the
yuan has been range-bound, moving no
more than 4% in either direction, when
measured against the trade-weighted
basket targeted by the People’s Bank of
China, known as the CFETS index. The
stability is particularly notable in the
context of the coronavirus: Despite the
upheavals that have occurred since the
beginning of 2020, the CFETS index
has barely budged, with the gap be-
tween its maximum and minimum
values coming in at less than 5%.
Yi Gang, the governor of the PBOC,
has said that this is deliberate, because
“a successful economy must keep its
currency stable.” A stated policy goal
of the PBOC is “basic stability in ex-
change rates.”
But this doesn’t happen naturally.
The Chinese government is again sup-
pressing the value of the yuan to boost
the profits of Chinese companies at
the expense of businesses in the rest
of the world and consumers in China.
The latest round of currency interven-
tion isn’t obvious because the People’s
Bank of China stopped openly buying
foreign exchange reserves in 2014.
Instead, the government is holding
down the yuan surreptitiously through
China’s state-run commercial banks.
One way to see this is by comparing
changes in the PBOC’s monthly hold-
ings of foreign exchange assets against
the monthly foreign asset position of
China’s commercial banks. While the
PBOC has shed about $1 trillion in
official reserve holdings since the peak
in 2014, much of that simply represents
a reallocation from one part of the gov-
ernment-controlled financial system to
another. More than $1 trillion in foreign
assets are now held by “other deposi-
tory corporations” against just $260
billion in foreign liabilities. The net
position of China’s banks has grown by
about $126 billion just since April.
Tellingly, the PBOC replaced its
foreign exchange reserves with yuan-
denominated loans extended to China’s
commercial banks. While the growth
in these loans doesn’t perfectly line up
with the growth of the commercial
banks’ foreign assets, or with the sub-
stantial reduction in their foreign lia-
bilities since 2014, it isn’t unreasonable
to think that the PBOC has helped
finance Chinese investments abroad.
The problem is that exchange rates
are supposed to move in line with
relative economic conditions, as inves-
tors buy and sell assets in search of
risk-adjusted returns. Stable exchange
rates make sense only in a world
where changes in productivity, infla-
tion, and spending are identical across
all countries.
While China, Europe, and the U.S.
all experienced similar downturns, due
to the virus, the rebounds have varied
widely in both size and composition.
China’s economy has snapped back the
fastest of the three, and while it would
be easy to attribute this success to the
government’s suppression of the virus,
that isn’t the main explanation. In fact,
consumer spending has recovered far
less in China than in America or Eu-
rope, because Beijing has been compar-
atively stingy in providing income sup-
port. Instead, China’s rebound has
come from a surge in exports to the
rich countries, even as its import bill
remains depressed, due to lower com-
modity prices and a cessation of inter-
national travel.
The favorable shift in China’s terms
of trade, the country’s relative success
at controlling the virus, and the
higher level of real interest rates in
China should all have contributed to
yuan appreciation, as foreigners
bought more Chinese assets than Chi-
nese invested abroad. Chinese con-
sumers, in other words, ought to have
benefited in the form of higher pur-
chasing power and higher imports.
That isn’t what happened, however.
Robin Brooks, chief economist at the
Institute for International Finance,
estimates that the yuan is roughly
10% undervalued. Even though for-
eign demand for Chinese stocks and
bonds has hit all-time highs, those
purchases have been more than fully
offset by other outflows from China
that hold down the yuan and preserve
the trade surplus.
The biggest of these outflows is “net
errors and omissions”—the unex-
plained gaps in the data that likely
represent capital flight by Chinese
savers moving their wealth out of the
country. NEOs have been worth about
$200 billion a year since 2015, with
the most recent quarterly numbers
(for April-June) showing unexplained
financial outflows of about $76 billion.
More recently, China’s state-run
banks have been ramping up their
foreign lending, their extension of
trade credits, their purchases of for-
eign bonds, and, especially, their di-
rect holdings of foreign currency and
deposits. The combination was worth
$66 billion in the second quarter—the
biggest quarterly outflow since 2016.
That’s been more than enough to off-
set foreign demand for Chinese fixed
income and foreign direct investment
into Chinese businesses.
“Something significant shifted in
China’s balance of payments in the
second quarter of 2020,” Brad Setser of
the Council on Foreign Relations re-
cently wrote. It “is going to be hard to
hide” the magnitude of Beijing’s inter-
vention in the currency markets over
the next few quarters, Setser thinks,
because the volume of outbound in-
vestments needed to offset China’s
trade surplus and foreigners’ continu-
ing demand for Chinese stocks and
bonds could easily be worth as much
as a half -trillion dollars.
Expect the question of whether
China is a currency manipulator to be
an increasingly contentious issue—no
matter who wins the presidency.B
By Matthew C.
Klein
Currency Curiosities
China's yuan exchange rates have been range-bound over the past few years, coinciding with a period
where the People's Bank of China cut foreign reserves and sharply expanded its lending to state-run banks.
Sources: China Foreign Exchange Trading System; Federal Reserve Board; Barron’s calculations; People’s Bank of China
102.5
Feb. 2016 ’17 ’18 ’19 ’20
100.0
97.5
95.0
92.5
90.0
2014 ’15 ’16 ’17 ’18 ’19 ’20
0
10
20
¥ 30 trillion
Jan. 1, 2016 = 100 Asset holdings and lending levels
vs. CFETS Index
CNY vs. USD
PBOC claims on other
depository corporations
PBOC foreign exchange
assets
tt