Currency manipulation and the relationship between the RMB and the USD
Date：08.09.2020
Author：Chen Yuan
On August 6th, the US Treasury department declared China a currency manipulator, a worrying development in the China-US relationship. This designation, in essence, reveals the United States’ intention to launch a financial war, a sign of the trade dispute escalating into a long and full-scale war. The US who puts the economic pressure in place will find it hard to wall itself off the consequences and avoid the negative impacts. Meanwhile, China should redefine the strategic role of foreign exchange reserves, from the highly reliable core asset to a financial war’s battlefield. Therefore, how to avoid the risk of foreign exchange reserves becomes a crucial problem that we have to solve.
To deal with American's unilateralism, China should not only reduce the short-term losses in economy or trade but more fundamentally gain independence from the USD. Although the journey to independence is long, it still deserves immediate action for the future initiative in the global arena. In the internationalization of the RMB, we should strengthen the currency’s role in commodities trading and international settlement. This effort will enable China to establish its own supply chain in the global market and create a favorable environment for China’s commodities trading market.
I. Foreign exchange issue can affect all
Exchange rate lies at the core of financial markets. It even occupies a more fundamental place in money markets as exchange rate policy can impact a country’s money supply, inflation and economic growth. For China, exchange rate policy can directly influence the country’s relations with the global monetary system, especially with the one of the world’s largest economy, the US. So it can be said that exchange rate represents a price ratio that bears very close relations with countries involved, their enterprises and individuals. It is a key measurable index.
Exchange rate has always been at the top of global trade chains and financial chains. That the US labeled China a currency manipulator is a move to disturb China’s financial market and destroy its economic order. The US intends to create disorder in China in order to defeat it during the two countries’ trade talks. Trump administration’s declaring China a currency manipulator is a sign that US has escalated the trade war to a financial war, signaling a new phase of the two countries’ frictions. This specific move has very important significance although a financial war might have been long planned.
An important question at present is what approaches the US will adopt after raising the issue of exchange rate. If the exchange rate dispute continues, how far and how long will its influence go? From my point of view, US intention to deteriorate exchange rate dispute will face difficulties from many sides and create numerous problems. Its influence will not only hit China, but also the US itself. It is extremely costly to use exchange rate dispute to suppress China’s finance and economy. Exchange rate can influence a financial system as well as trade and economic relations between countries. Take Japan as an example. After signing the Plaza Accord, Japanese yen appreciated accordingly, which led to restructuring of the Japanese economy. The country’s capital intensively went to the real estate market and then created the housing market bubble, making Japanese economy heavily suffer. Meanwhile, some industries explored overseas investment opportunities and promoted Japan’s foreign investment and internationalization.
From Japan’s experiences it can be seen that foreign exchange problems can lead to negative impacts such as real estate bubbles and financial bubbles. Its positive influence is that it forced Japanese businesses to look for new investment opportunities in the global market. Prospects of foreign exchange markets are filled with uncertainties. China needs to draw lessons from other countries and respond to foreign exchange issues seriously.
II. Financial war will be more systematic and persistent
US labeling China as a currency manipulator signifies trade war escalation, making the conflicts between the two powers more systematic and persistent. It directly affects the ratio between the countries’ currencies, which will further highlight Chinese yuan’s weaknesses and US dollar’s advantages. When compared to the US dollar, Chinese yuan is obviously at a weak position. At present, renminbi mainly serves its domestic economy, while its internalization journey has just started. Though having joined the SDR basket, Chinese yuan still accounts for only a small part in investment and settlements on a global scale. Against this background, it is unwise to let Chinese yuan move against the US dollar.
It is true that China has achieved greatly in the domestic monetary and financial markets. However, regarding the global market, the US has long seated itself top of the world, naturally leading to the US dollar’s hegemony. China should never confront US advantages with its weaknesses and a financial war of a larger scale should be avoided. It is clear that the US wants Chinese yuan to rise in order to constrain China’s export. That Chinese yuan dropped below 7 to the US dollar did improve the country’s export in a short term, which is obviously against US interests. In this case, the US is very likely to take measures in investment and other financial businesses. In the face of these potential problems, China needs to remain highly vigilant and be fully prepared.
The US wants to earn more profits through containing China’s financial and economic development using the tool of foreign exchange. Though the US may seek to decouple itself from China, it is hardly possible to do so in the foreign exchange and monetary markets. China now holds considerable foreign exchange reserve, which includes more than one trillion of US debt. From the perspective of geopolitics, China’s owning US debt makes it have influence over US financial market. But it needs to be pointed out that the influence is very limited, not able to constrain the US systematically. US-China decoupling financially can be extremely hard, but China still needs to get prepared against any US action.
The financial war starting with foreign exchange issues has far more larger and deeper influence than a trade war. China and the US are too intertwined with each other, so it is impossible to avoid negative impacts when decoupling happens. China has to prepare itself against an escalating financial war and more harms it will bring.
III. The strategic positioning of foreign exchange in economy needs to be adjusted
Over the past 4 decades of China’s economic reform, China’s foreign exchange reserves has been a huge asset made by Chinese people through their efforts in exporting and importing businesses since the beginning of China’s reform and opening-up four decades ago. It is not only a wealth for the society as a whole, but can also directly affect the issuance of RMB and stability of prices, which indicates an important strategic position. Currently, this strategy status has been encountered a huge challenge, as the foreign exchange market has become a target of the “trade war" and even "financial war". In the past, China and the US carried out extensive and in-depth cooperation and integration in the money market. Although the issue of exchange rate manipulation was also raised then, the US had never really fully exerted its full pressure on exchange rate market. From a period of relatively stable cooperation to one when the US gets hard on China, the meaning of China's huge foreign exchange reserves has changed apparently to the American. Exchange rate issue could become associated with geopolitical and national issues between the two countries, and a tool for the US to further impose pressure on China. At this moment, we must consider a new strategic meaning of foreign exchange reserves as a financial battlefield and even the focus of a "financial war."
For a long time, foreign exchange has been an extremely important asset for China. Without huge trade surplus and foreign exchange reserves, it would have been quite difficult for China to achieve economic development achievements as we have done over the past 40 years. Without the support of foreign exchange reserves, the import of large amount of primary product resources and high-end chip products critical to China’s economic development would have not been able to be realized. It could be said, because of the accumulation of large foreign exchange reserves, China has maintained rapid economic development and achieved relatively good outcome for a long time in a low inflation environment thanks to a favorable environment on international trade and financial markets. If we used to treat foreign exchange as an important cornerstone of economic development, we must have a clear understanding of the repositioning of foreign exchange given the US intention now to shake and dig this cornerstone. Although foreign exchange is one of the most important core assets to Chinese residents, the US may use various means to suppress and contain Chinese economy in the foreign exchange market in order to “weaken its opponents while consolidating its hegemonic status”. Then, the safety of foreign exchange reserves would be threatened first.
A large amount of China's huge foreign exchange reserves have been denominated in US dollars for a long time. Technically the foreign exchange market is in the hands of the US, which can cause negative impact on China. To address the strategic positioning of foreign exchange, fundamentally we should strengthen the development of RMB. Yuan has witnessed a long-term stable operation in China since China’s founding day 70 years ago, and will continue to be so. In the future, the international influence and status of RMB will still need to be further strengthened. We must shift the strategic positioning of foreign exchange reserves from its initial role as a "highly reliable core asset" to "a new focus of financial war or even a new battlefield." How to protect and effectively allocate China's foreign exchange reserve assets so as to avoid the impact of the "financial war" will become the most important issue. At the same time, we must reconsider the status of foreign exchange in national economy, which should take into account both good and potential bad scenarios, in which the US might take all measures to weaken our financial wealth that has been accumulated in a long period. China currently has a large amount of US dollar as part of the reserve assets. China should pay close attention to and take a series of effective measures in order to avoid potential risks associated with foreign exchange reserves.
IV. Avoiding damage of exchange rate conflicts to China's economy and trade in short term
A response to the "financial war" started by the US is to avoid further conflicts between the two countries in foreign exchange market and to reduce the adverse impact of fluctuation of exchange rate on the economy. First of all, the flexibility of exchange rate should be increased to make it more resilient against attack by the US. Both the implementation of a floating exchange rate regime and appropriate capital control are needed. The US has identified the normal depreciation of RMB on the exchange rate market as man-made manipulation, which is obviously wrong. But we should make the exchange rate management system even closer to international conventions and market rules in the future. For some time in the past, part of what we did has been an effort to satisfy the IMF and the US Treasury. Now, we need to not only maintain the consistency and uniformity in terms of China’s image on international stage, but also to maintain the rationality of our policy, which can help China win universal moral support and help from other countries. At the same time, we must be cautious against the situation in which the US attacks China with "currency manipulation" issue, imposes more sanctions, especially in the financial sector. Therefore, both the two measures should be used, to ensure that China can occupy the moral high ground, have sound reasons to refute and secure world more support facing accusations from the US. For example, on the issue of "exchange rate manipulation," the IMF did not agree with the US. So we can still make full use of various conditions to improve our situation.
Second, there must be a long-term response to the "exchange rate manipulation accusation." In the past, the US accused China of "exchange rate manipulation" only occasionally, but the "Sword of Damocles" actually hangs over China for a long time. For example, the US always lists China on an observation list of exchange rate manipulation, and when it finds necessary to label China a currency manipulator, it will do. For this problem, we shouldn’t just regard it as a short-term event again and again. Although historical experience shows that listing China as a “currency manipulator” is a special act taken by the US in a specific period of time and it would be adjusted and changed after a period of time. But this issue could become as a medium- and long-term issue as the China-US trade friction escalates. We should try our best to make this "exchange rate manipulation" accusation into a short-term one. However, we must also get fully prepared. Once the US puts pressure on China by making it a medium- and long-term issue, China must have clear measures to combat it.
Third, we must increase the international pricing power of the RMB which was officially included into the SDR. However, compared to other currencies in SDR, RMB is not fully internationalized yet, and international pricing capability of RMB should continue to be strengthened. We must continue to enhance the penetration and expansion of RMB, which requires joint efforts from all sides. We should take more innovative means, be brave to try and discover new development areas, and constantly improve the international voice of RMB.
V. RMB internationalization for independence from the USD
To deal with the suppression resulted from the US-fueled war, the fundamental solution lies in reducing dependence on the USD in the pursuit of economic growth. At the start of reform and opening-up, China relied excessively on exports and then the problem was tackled. However, overdependence comes back because of the long accumulation of foreign exchange reserves and extensive trade cooperation with the US, which leaves the US an economic weapon to use foreign exchange against China. In the long term, we must reduce our dependence on the USD.
To this end, one option is to expand the use of other reserve currencies but it can work in only certain regions. Around the world, in the trade settlement and reserves investment, no other currency is used as much as the USD. This plan may work but the impact will be very limited.
The other option, the most fundamental solution, is gradual internalization of the RMB and its more presence in the commodities market. In the global market, commodities which constitute strategic resources are connected with capital market through its pricing mechanism. Commodity prices are shaped by the prices of commodities futures and currency futures, and futures are components of the capital market.
The internalization of the RMB does not simply mean to issue and deposit the RMB in foreign institutions or the overseas branches of Chinese-owned institutions but to facilitate the use of the RMB in the international commodities market and to use the RMB for settlement in the oil, natural gas, iron ore and agricultural commodities transaction. For some countries abundant in resources, their currencies are not internationalized, which provides great opportunities for the RMB. China should leap at the chance and promote the internalization of its currency, which will raise its status in the world commodities market and reduce the dependence on the USD. Therefore, it is of great significance to strengthen the role of the RMB in commodities settlement and trade settlement.
In addition, we should find new alternatives to replace the USD’s role as an indicator for wealth so that we will not depend too much on the USD. It will be hard because there is still a long way to go for the RMB to become the reserve currency. However, we should follow this path, do research and design some possible alternatives as contingency plans.
All in all, the designation made by the US reveals its intention to launch a financial war, which poses challenges to China and make new requirements for our work. To deal with American's unilateralism, China should not only reduce the short-term losses in economy or trade but more fundamentally gain independence from the USD. Although the journey to the independence is long, it still deserves our immediate action for the future initiative in the global arena and groundwork of the RMB’s internationalization. This effort will enable China to establish its own supply chain in the global market and create a favorable environment for China’s commodities trading.
