Despite a public health crisis that decimated the world’s second-largest economy, the Chinese yuan has stabilized this year after facing a historic collapse in 2019. The consensus on Wall Street is that you can anticipate additional weakness for the rest of 2020 but unlike what foreign exchange markets witnessed a year ago. With a second wave of COVID-19 beginning to form in pockets of China and the start of a capital flight among that nation’s wealthiest people, could there be a currency crisis? This might explain the central government’s recent internationalization and de-dollarization campaigns.
The sentiment in China is that domestic conditions are deteriorating, economic prospects are grim, and the yuan will flounder in the years to come. Why stay?
The Nikkei Asian Review published an in-depth piece that examined the growing trend of Chinese citizens increasing overseas investments, setting up U.S. dollar accounts, and buying foreign real estate and insurance products. Although Chinese capital outflows were just $1 billion in the first quarter because of travel bans and the pandemic, estimates suggest this figure will spike in the coming quarters when borders reopen.
A capital exodus has yet to be ubiquitous, but the groundwork is being laid. If these trends amplify and persist, the yuan could endure additional depreciation. A weakening currency is good for the export-oriented economy, but debasement is never a positive development for the citizenry – both affluent and impoverished. The Chinese people have a contingency plan. They are willing to relocate anywhere and invest in anything that would shield their hard-earned wealth from the totalitarianism and incompetency of President Xi Jinping and his Communist government.
There are global developments that could reverse this trend. With the U.S. election around the corner, a victory for Joe Biden would be beneficial for Beijing since he would likely take a less aggressive approach to China. Global market uncertainty could erect a barrier for Chinese investors who want to take the money and run – if it is scary outside, then why leave? Rising bond yields in China compared to those in the United States could also attract foreign money if chaos ensues in financial markets.
But Chinese officials may not want to wait for chance to determine their fate.
A Fork in the Belt and Road
In 2013, Beijing established the Belt and Road Initiative (BRI), a $4 trillion infrastructure investment campaign to build rail, road, and sea routes that connect China to Africa, Central Asia, and Europe. The goal is to boost commerce, and many trading partners have been gung-ho about the plan. The level of excitement might be diminishing as participants take on hundreds of billions of dollars in loans and impoverish their budgets to help repay Chinese banks. Their frustrations could be mounting.
BRI countries are being encouraged to ditch the U.S. dollar and use the yuan for cross-border transactions. The yuan is not used that much in global trade, and it accounts for less than 2% of global currency reserves. China has been trying to reverse this long-term trend by internationalizing the yuan and expanding its de-dollarization blitzkrieg.
Nearly all BRI participants have refrained from accepting yuan-denominated loans – most are executed in U.S. dollars. Pakistan is the lone exception, likely because the rupee has little value. Countries do not view the yuan as useful in international transactions or foreign reserves. But if citizens are absquatulating from their currency, then the government would require outsiders to invest more in the currency. What better way to do that than to strong-arm nations that have a considerable stake in the BRI?
Central Bank Digital Currency (CBDC)
Could a digital currency prevent a collapse in the yuan? The People’s Bank of China (PBoC) has been working on a cryptocurrency to replace fiat cash, which would add to the authorities’ surveillance powers and allow the government to prevent a capital exodus. Officials have also been blunt that the digitalization of the yuan would facilitate its efforts to compete with the greenback and accelerate its 20-year-old internationalization push. Some see the central bank-backed virtual currency as benign. Others view it as a quest to maintain its dominance and authority – at home and abroad – in the digital age. Crypto is a powerful tracking tool for law enforcement, so one can imagine it in the hands of an autocratic regime.
The Red Dragon’s Breath
The Chinese economy will never return to the way it was a few years ago. The housing bubble, the U.S.-Sino trade war, and the Coronavirus pandemic exposed the poor health of the paper tiger. It runs on a Ponzi scheme economy where everything requires new debt to cover old debts, and it requires only a small gust of wind to force the house of cards to come crashing down. A currency crisis might be in the making, and it would exacerbate the myriad of problems that are extinguishing the red dragon’s fiery breath. The 21st century was supposed to be Made in China, but Beijing’s arms were just too short to box with the laws of economics.
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