It seems like China, ground zero for the coronavirus global pandemic, has been relatively unscathed by the public health crisis. Beijing was one of the few major economies to record growth in 2020, thanks to ultra-aggressive fiscal and monetary support. For the last several months, the pertinent metrics of a healthy economy have been improving as expected. During this period, a surprising trend has been the appreciation of the yuan, climbing to its highest level against the U.S. dollar in 30 months. Chinese policymakers have allowed the yuan to strengthen – for now – and this could have ramifications for the United States in 2021. So, what does a strong yuan mean for America and the rest of the world?
A Tale of Two Currencies
At the height of the COVID-19 pandemic, the yuan had slumped about 2.5% to as low as 7.718 per U.S. dollar. Throughout the trade war with President Donald Trump, the yuan had faced weakness, hovering around the 7 mark, forcing the Treasury Department to label China as a currency manipulator. By June, the yuan peaked and started to advance against the greenback, hitting a near three-year high of 6.51 per dollar.
The U.S. dollar has endured an inverse performance. After soaring to a four-year high of 103.00, the U.S. Dollar Index (DXY), which gauges the greenback against a basket of currencies, cratered about 15% and slipped below the 90.00 threshold.
What does 2021 have in store for both currencies? Unless President Xi Jinping's merry band of Communists intervene, the yuan could test the 6 level. Should the global economy maintain its path of recovery, the DXY could remain in a bear market.
Will the Yuan Go MAGA?
In October, the U.S. trade deficit widened to $63.1 billion as exports rose 2.2% to $182 billion and imports jumped 2.1% to $245.1 billion. China represents most of the gap in America's balance of trade, since Beijing exports close to $52 billion per month to the United States.
A continual rise in the yuan might eat into the U.S. current account deficit. It is unclear by how much, but a strengthening yuan could lead to a repatriation of corporate operations and greater American job creation. It is unclear of the impact in today’s landscape, but economists have previously estimated that the U.S. gains approximately 6,000 jobs for every $1 billion of improvement in the trade balance.
As Liberty Nation reported, many U.S. companies had been exiting China since before the pandemic because of the trade dispute. The problem is that these businesses are relocating to other markets with cheap labor and business-friendly policies, such as Vietnam, Thailand, and the Philippines.
Still, the last time there was talk of a rising yuan helping the U.S. job creation occurred in 2011 when the yuan had appreciated close to 7% between June 2010 and October 2011. The U.S. government had then complained about currency manipulation, plus China’s real estate and stock market bubbles popped, erasing the yuan’s gains. It would not see another rally until May 2017, which lasted for only a year.
Over the last two decades, a stronger dollar and a weaker yuan had been a boon for cost-conscientious consumers, giving shoppers greater purchasing power, which is crucial for low- and middle-income households. This was one reason why price inflation had not been as fierce, despite the trillions in newly created money by the Federal Reserve. Indeed, you could step foot inside a Walmart and purchase many products for $100 because they had been imported from China.
It could be mean bad news for American consumers should the dollar trend lower and the yuan travel upward, particularly as millions of households recover in the aftermath of the coronavirus-induced economic collapse. U.S. shoppers would endure higher prices for a diverse array of goods, including computers, clothing, furniture, chemicals, electrical equipment, and plastic and rubber products.
Until the U.S. economy starts importing more from Vietnam and Thailand, the cost of T-shirts and tablets could balloon. By the time the U.S. makes the transition, however, it may already be too late. Over the last 12 months, the Vietnamese dong has risen more than 2% against the buck. Since 2015, the Thai baht has popped nearly 18% against the dollar.
What happens if other currencies strengthen and the dollar weakens? Could this result in the U.S. transforming into an export-oriented economy as it was before the globalization crusade commenced? In addition to currencies, other factors weigh on the production of consumer and durable goods, such as labor, taxes, and tariffs. The U.S. offers some of the world's highest wages, so it would be hard to compete against low-wage markets selling flip-flops and snow globes in the global economy, even if the buck falls.
Seen Yuan, Seen ‘Em All
A new trend was born in 2020: Central banks producing digital currencies, also known as CBDCs. The country leading the CBDC charge? China.
For the last several months, there have been many internal talks to internationalize the yuan and make it a more significant player of cross-border commerce transactions. Whether this is a part of efforts to boost the yuan amid capital flight or the global de-dollarization push, the digital yuan is set to play an imperative role in the Chinese economy. As Liberty Nation reported in June 2020:
"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."
In recent months, Beijing has been rolling out the digital yuan in phases as part of experimental initiatives. Since the summer, billions of dollars' worth of transactions have been executed nationwide using its blockchain technology, from Shenzhen to Chengdu to Xiongan. Officials already have high hopes for the digital yuan, such as lotteries and gamification.
But could it displace the dollar? Former PBoC head Zhou Xiaochuan recently told the Shanghai Forum that it is not a threat to global monetary systems because the primary objective is to better process payments and manage foreign exchange transactions. Zhou thinks it could also transform bilateral trade.
Andrew Leung, an independent China strategist, believes a virtual yuan could thwart the U.S. dollar trap. He writes in an op-ed in the South China Morning Post:
"While the United States and Western allies are not about to warm to China‘s digital currency any time soon, more countries in Asia, Africa and Latin America are likely to embrace the convenience and opportunities of China’s digital payment systems, made even easier and safer by its sovereign digital currency. This trend is likely to accelerate with the commencement of the Regional Comprehensive Economic Partnership, comprising a third of the world’s population and a third of world GDP."
The U.S. dollar was no longer the world's most used payment currency this past fall, falling behind the euro. However, the greenback's global reserve currency status enhanced in the third quarter of 2020 to 61%. What other currency experienced growth during the July-September period? The yuan, climbing from 1.9% in the first quarter to 2.1% in Q3.
No Yuan Wants a Strong Currency?
Citigroup recently forecast that the yuan would appreciate another 10% by the end of next year.
Investors in foreign exchange markets wondered if the authorities would permit the yuan to appreciate any further. While the central bank has not thrust itself into the forex markets with guns blazing, policymakers have taken a more gradual approach to installing a ceiling to the yuan’s ascent. In December, the central bank confirmed that it would decrease capital inflows by an unspecified amount and lower cross-border financing. Despite experiencing capital outflows in the first half of 2020, China has witnessed ballooning capital inflows, contributing to the yuan’s impressive rally this year.
Still, traders were optimistic over the yuan's long-term strength, especially on reports that the PBoC would taper its ultra-aggressive easing program next year amid a recovering economy.
But the PBoC also needs to strike a delicate balance between micromanaging the yuan and adhering to President Xi's promises of market-oriented reforms. In the U.S.-China phase one trade agreement, Bejing would intervene less in forex markets, and both American and Chinese parties would regularly communicate and consult on forex matters.
Ultimately, Chinese officials need to weigh between being competitive and allowing the market to determine the currency's performance. Switzerland tried to cap the franc’s appreciation, but its efforts have been in vain. Not only has the franc continued to experience vast acceleration, but it was also slapped with a currency manipulator designation by the U.S. Treasury.
Crisis and Opportunity
Is the Chinese yuan set to become a safe-haven asset a la the dollar, the Swiss franc, and the Japanese yen? China has been sending mixed messages about what it wants. Does China desire the yuan to become a global reserve currency titan? Or does it wish to diminish its value to remain competitive in the international marketplace? If Beijing chooses to takes a hands-off approach, the yuan could meet market expectations and test the 6-per-dollar level by the end of 2021. In China, a crisis is viewed as an opportunity, and the devastating coronavirus pandemic turned out to be the nation's Great Reset: a new five-year plan, increased government power, a swelling stock market bubble, and the yuan transforming into a dragon. The new normal could consist of a new Chinese economic model.
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Read more from Andrew Moran.
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