The case for a stronger Chinese yuan

Asia Times

27-05-2025

The uptick in the yuan since Chinese and US trade officials met in Geneva has traders wondering if a currency agreement was struck behind the scenes.
Only Chinese Vice Premier He Lifeng, US Treasury Secretary Scott Bessent and their aides know for sure. But the yuan's recent appreciation flies in the face of an economy experiencing a property crisis fueling deflation and a central bank in easing mode.
Nevertheless, the yuan's performance has Goldman Sachs betting on Chinese stocks benefiting from further yuan gains.
'Chinese stocks tend to perform well when the currency rises,' says Goldman Sachs strategist Kinger Lau. The yuan outlook, he adds, lends support to the bank's 'overweight stance' on Chinese stocks. Lau says that every 1% increase in the Chinese currency tends to result in a 3% jump in mainland equities.
Yet even if some understanding wasn't reached with Donald Trump's administration on the yuan in Geneva earlier this month, as some traders and analysts suspect, China's tolerance of a stronger exchange rate is a good omen for Asia's biggest economy.
On one level, yuan-denominated assets are experiencing a renewed burst of demand as President Trump's tariffs drive a 'sell America' narrative. On another, they're coming into their own as US chaos sends investors to the relative stability of China.
This is, after all, what Xi Jinping envisioned back in 2016 when he made yuan internationalization a top priority.
Nine years ago, Xi launched a long-term plan to morph the yuan into a top-tier currency. That year, he scored a spot in the International Monetary Fund's reserve currency basket alongside the dollar, yen, euro and pound.
Today, we see that the yuan has Japan looking over its shoulder. And it's putting the US on edge as nations around the globe search for an alternative to the dollar.
Yet given the scale and importance of China's US$18 trillion economy in commerce and finance — it's the top trading partner of more than 120 economies — the yuan remains underutilized.
This owes to Xi's Communist Party continuing to prioritize control over flow. It has yet to allow full convertibility and People's Bank of China decisions remain the purview of Xi's inner circle.
The International Monetary Fund says China's currency accounts for just 2.2% of global foreign exchange reserves versus nearly 58% for the dollar and 20% for the euro. As of April, payments messaging network SWIFT says the yuan is involved in 3.5% of global payments. This puts the yuan fifth after the dollar, euro, pound and yen.
But Trumpian chaos is a unique opportunity for Xi to turbocharge the yuan's global use.
On a very basic level, notes independent economist Andy Xie, letting the yuan rise would communicate 'confidence' to global markets. Also, Xie argues, it would help Beijing 'reduce its structural weakness' and help 'encourage consumption and discourage overcapacity.'
There are more immediate reasons why President Xi, the PBOC and the Finance Ministry have been reluctant to drive the yuan lower. One is managing default risks. Every drop in the yuan makes it harder for the most highly leveraged property developers to make payments on dollar bonds.
A weaker yuan also works at cross purposes with Beijing's multi-year effort to reduce leverage. It also might irk Trump World, upping the odds that 145% tariffs are reimposed.
But independent of geopolitical events, a rising yuan is very much in China's economic interest. Just look at Japan's experience with an undervalued exchange rate these last dozen-plus years.
Though Tokyo has favored a weaker yen since the late 1990s, the push took on new urgency in 2012 when Shinzo Abe returned to the premiership. Abe hired a new Bank of Japan governor, Haruhiko Kuroda, to drive the exchange rate sharply lower.
Kuroda did just that. He slashed official interest rates and hoarded bonds and stock. The yen's 30% drop was meant to boost corporate profits to create a virtuous cycle of increased wages and consumption to end deflation.
Instead, a weaker yen unleashed a bull market in complacency. Abe's big talk of modernizing labor markets, cutting bureaucracy, supporting startups, empowering women and attracting top global talent took a backseat to manipulating exchange rates.
Rather than do the heavy lifting to retool the economy, Abe prodded the BOJ to go even further into uncharted territory, opening the monetary floodgates. Unfortunately, it backfired on Japan, whose gross domestic product has shrunk as a result.
All four Japanese governments that ruled since late 2012 prioritized yen depreciation over moves to increase competitiveness. Aggressive quantitative easing took the pressure off politicians to level playing fields. It took the onus off CEOs to innovate, restructure and swing for the fences.
That's now blowing up on Prime Minister Shigeru Ishiba, as Japan imports too much inflation, too fast. The 3.6% inflation is nearly twice the BOJ's 2% target. And productivity is waning, too, a product of years of foot-dragging on moves to level playing fields.
China needs to avoid this dynamic. There are myriad reasons why. One is projecting economic confidence.
As former Morgan Stanley economist Xie argues, a rising exchange rate is a sign that Beijing is comfortable with its ability to accept the judgment of global markets. And that Team Xi is walking the walk on claims that it's seeking increased capital flows from abroad.
A rising exchange rate is ultimately a show of surety. And those capital inflows pull in more long-term investment, lower bond yields, tame import prices and encourage governments to spend more time raising their economic games, rather than manipulating markets. A rising exchange rate also would help Beijing pivot away from the dollar more forcefully.
More buoyant capital markets are a precursor to creating new, good-paying jobs from the ground up, not protecting state-sector jobs from the top down. This, in addition to building bigger social safety nets, would help accelerate China's transformation into a consumer-driven nation.
Also, it would globalize the yuan for real. Since 2013, Xi has pledged to let market forces play a 'decisive role.' They're meant to reduce the amplitude of yuan gyrations without Beijing manipulating market dynamics in ways that irk the IMF and Trump's Treasury Department.
Since 2016, the yuan has been in the IMF's top-five currency basket. That requires China to liberalize the financial system, loosen the capital account and move toward letting markets decide the yuan's value. These dynamics, in turn, will get Xi closer to his goal of the yuan rivaling the dollar as a global transactional currency of choice.
It's a vital part of the reform process. Shifting China's growth model more assertively away from exports once and for all means Beijing must become a bigger importer of capital. A rising yuan serves that goal.
A rising exchange rate would also accelerate China Inc.'s move upmarket. Japan, a far more developed economy, is a cautionary tale of weak exchange rates undermining innovation and productivity. In the short run, a falling currency boosts corporate profits and government coffers. Yet, it's a crutch that stymies economic development in the long run.
Why bother restructuring, inventing new products or shaking up vested interests when government currency managers have your back? Rather than modernize operations and make bold changes, executives papered over cracks with weak yen-driven profits. South Korea, too, has often faced a similar complacency dynamic with its giant, coddled, family-owned conglomerates.
At the same time, historical evidence is quite clear that a strengthening currency is generally supportive for the equity market, as Goldman Sachs strategists argue about China. It also has investors pivoting to Chinese bonds.
Not just as a hedge against shaky US Treasuries but also because China is exuding the kind of broad confidence fixed-income investors seek and crave.
Follow William Pesek on X at @WilliamPesek