Donald Trump’s demand for stable yuan to end US-China trade war ‘acceptable’ to Beijing

A demand from the United States that explicitly requires China to keep the yuan exchange rate stable as a condition to end the ongoing trade war plays right into Beijing’s hands, and is an offer the government in Beijing will accept, said analysts.

The US has demanded that China stop devaluing the yuan as a condition of ending the trade war, and the two countries may include currency policy in a memorandum of understanding that would form the basis of a trade deal, Bloomberg reported.

For years, the US government had been pressing China to adopt a market-oriented exchange rate system so that the yuan can find its “fair value” against the US dollar.

China officially scrapped the yuan’s “hard peg” to the dollar in 2005 and adopted a “soft peg” under a “managed floating exchange rate system”, allowing the exchange rate to fluctuate within a narrow range.

If the Trump administration changes its focus on the yuan’s exchange rate formation mechanism and specifically requests China to prevent the yuan from depreciating to a certain level, such a demand will fit immediately into what Beijing has been doing since the summer of 2015, according to analysts.

The reports that Trump has demanded a stable yuan sent China’s currency to its biggest gain against the US dollar in more than three weeks.

The yuan rose 0.51 per cent to 6.7242 per dollar in China on Wednesday after earlier in the day rallying by as much as 0.58 per cent, its biggest daily gain since January 25.

A deal between China and US that requires Beijing to keep the yuan exchange rate above a certain level would be a recognition of Beijing’s long-held guiding principle of “keeping the yuan stable at a reasonable equilibrium”, said Ken Cheung Kin-tai, senior Asian currency strategist at Mizuho Bank.

“From China’s perspective, this would also be acceptable,” he added.

Cheung said that China has already been making efforts to stabilise its currency to alleviate fears of yuan depreciation and to boost the currency’s international appeal.

“Yuan stabilisation will be the optimal solution to balance out risks of capital outflow, trade negotiations and China growth slowdown,” he added.

Beijing has been relying on heavy intervention and draconian curbs on capital outflow to keep the yuan from weakening below the key level of 7 against the US dollar over the last year amid a trade war with the US, which saw the yuan drop 5 per cent against the US dollar last year.

In the onshore market, the People’s Bank of China sets a daily parity price in Shanghai for every trading day that allows the yuan to move in a narrow range of 2 per cent up or down, while in the offshore yuan market in Hong Kong, the price is slightly more volatile but China’s central bank still has an influence.

Janet Yellen, the former chairwoman of the US Federal Reserve, said on Wednesday that the United States had been concerned about Chinese intervention in foreign exchange markets to hold down the yuan value “to stimulate growth and [seek] large current account surpluses” for many years.

This was up until 2015 when such concerns were replaced by worries over “downward pressure on the Chinese currency”, especially since August 2015 when a modest devaluation caused panic in global financial markets, added Yellen.

“People judged that perhaps [in 2016] there had been some secret accord that involved China changing its exchange rate policy in return for the US easing off on monetary policy,” said Yellen, who chaired the US Federal Reserve from 2014 to 2018.

“Now, let me quickly say there was no Shanghai Accord if that’s interpreted to mean an explicit agreement or some secret handshake deal.”

During his election campaign, US President Donald Trump had threatened to label China as a currency manipulator because he alleged it was devaluing the currency to make Chinese goods artificially cheap – an allegation that many economists at the time viewed as outdated.

Trump eventually backed down from this threat and the quarrel over the yuan cooled, even though a tariff war broke out between the world’s two second largest economies last year.

Vice-Premier Liu He will continue the next round of trade talks with US counterparts including US trade representative Robert Lighthizer and US Treasury Secretary Steven Mnuchin this week in Washington.

From a pure trade point of view, a currency depreciation in theory can offset the impacts of additional tariffs.

Michael Every, senior Asia-Pacific strategist at Rabobank, said if the US imposes 25 per cent tariff on all Chinese goods after the March 1 deadline but China allows the yuan to depreciate 25 per cent against the dollar, then “not a lot has changed”.

In reality, however, China is facing an uphill battle in keeping the yuan strong enough.

“Logically, the only way China can keep their currency stable or stronger is to open up the economy in a big enough bang that foreign capital inflows exceed any outflows: that’s the deep-seated structural reform that is a no-go for Beijing,” added Every.

At the same time, fears over yuan depreciation have receded this year because of a softer dollar as the US Federal Reserve slows or even ends its interest rate hiking cycle.

There are other market factors which may boost the yuan this year, which may also affect Beijing’s decision on whether to accept a deal on currency.

One is higher foreign investor interest in yuan-denominated assets, with Chinese stocks and bonds set to be included in more global indices, said Amanda Stitt, head of the fixed income product specialist team at Legg Mason Global Asset Management.

Chinese yuan government and bank bonds will be added to the Bloomberg-Barclays flagship Global Aggregate Index from April.

This will lead to around US$150 billion of potential bond inflows over a 20-month period, or US$50 billion per month, said Frances Cheung, head of macro strategy Asia at Westpac.
Source: South China Morning Post