Paper Tiger Currency

China Currency Note

Talk to any Marxist practitioner, he or she will tell you that it’s the “internal contradictions” that will do you in, in the end. So, it is with irony that we see a country like China that has been a preeminent beneficiary of globalization beset by isolating strictures applied to money and perhaps the mind. China is indeed an engine for global trade, and is attempting in some ways to forge a potential post-WTO world, with all the power and moxie that implies. A continuing insulated domestic currency nevertheless offers an odd contrast and carries a situation further imbued with risk – but, hey, things could work out, for a long time, right? Maybe so, but global lenders and investors should take note of the renminbi’s seeming internationalization, yet its strange absence.

An interesting relationship – about 7.2 renminbi (CNY) corresponds to a single US dollar, the demonstrative CNY exchange rate. And an interesting statistic to ponder, the People’s Bank of China (PBoC), the country’s central monetary authority, manages foreign exchange reserves at roughly USD 3.2 trln, a level with increasing tenure and some significance. One statistic, the exchange rate, seems to be more of a description rather than a feature. It just is what it is. The other one, the official foreign exchange holdings, seems to be more a sign of rude good health.

Neither though offers a complete picture.  Simple statistics don’t, not by themselves. Context and history, recent history for that matter, can offer a better perspective on what we’re dealing with.

The CNY numbers officially, as it were, among the world’s reserve currencies. In 2015, the International Monetary Fund (IMF) included the renminbi in its Special Drawing Rights currency basket, signaling that the Chinese currency had in effect arrived.

Selection for the SDR represents in some ways the culmination of an economic dynamic that the noted Czech social scientist and policy analyst Vaclav Smil describes succinctly here, “What a remarkable symbiosis: a Communist government guaranteeing a docile work force that labors without rights and often in military camp conditions in Western-financed factories so that multinational companies can expand their profits, increase Western trade deficits, and shrink non-Asian manufacturing (ICFTU, 2005).  More of the same is yet to come…”

(see Vaclav Smil, Global Catastrophes and Trends: The Next Fifty Years, Cambridge/London: MIT Press, 2012)

Smil published the observation cited above in 2012, and the broad lineaments of that observation still hold true. To paraphrase an adage that once applied to the industrial workshop known as Trenton, NJ, and still applies largely to China, that is, “China makes, the World takes.”

That indeed holds true. This past December, China posted merchandise exports amounting to USD 303.62 bln, contributing to annual total of USD 3,381.62 bln for 2023, according to the data vendor

What may be enervating this preeminence somewhat and what was not evident in 2012 was the change in approach reflected both in China and its strategically important trading partners, the EU and the US. In 2012, President Xi Jing Ping assumed the leadership role in the People’s Republic of China, and began adopting a more assertive foreign policy stance, catalyzing some reaction from international partners. In 2016, the newly elected US administration chose to become more confrontational, imposing tariffs on Chinese export goods. 

China re-assessed further, seeking to shape international institutions and fashion new ones more consistent with the Chinese perspective on global affairs. In 2013, China began its Belt and Road Initiative (BRI) investment program that grew to focus on infrastructure development for 140 participating countries from regions including Asia, Africa and Latin America.

China’s policy makers also fashioned “free trade agreements” (FTAs) that lowered tariffs and facilitated direct investments into countries covered by these agreements. The Financial Times comments, “This (trade) network – which currently includes 28 countries and territories that take close to 40 per cent of China’s exports – means that if the WTO’s mandate to keep the world open for liberalized trade unravels, China will have at least a partial back-up system in place… None of China’s FTAs include the US or countries inside the EU.”

(see “China’s Plan to Reshape World Trade on its own Terms,” Financial Times, 2/26/24)

But what of the currency? How has the CNY reflected the shifting currents of trade, domestic demand, capital investment, and sentiment – both foreign and domestic? Such shifting trends and sentiment generally effect exchange rate value. For the CNY, one could answer it has been very measured.

Currency represents the sovereign’s ultimate act of reciprocity with the resident holder of that currency, or non-resident holder, in fact. The sovereign authority issues the currency (a promise to pay…), with the currency also representing “a ticket to ride”. With the currency, the holder has the ability and the ongoing discretion to participate in the economy and markets of the issuer, who has stewardship of the public institutions and laws that determine a major part of the appeal of that economy and those markets.

A more freely floating currency reflects in a more unalloyed way the value of the economy and markets under the jurisdiction of the sovereign issuer. Controls in effect abridge that correspondence between currency value and the perceived value of the “fundamentals” (e.g. society, economy and markets).

Maybe analogous to interdicting the existence of another political party, the Chinese authorities have maintained steady controls on the CNY, affecting what holders of the currency can and cannot do. In short, there shall be no vote of confidence on the currency.

To wit, resident individuals may exchange renminbi for an equivalent USD 50,000 in foreign currency in a given year, amounts exceeding that level require approval from the State Administration and Foreign Exchange (SAFE) apparatus. For those investors falling under the Qualified Domestic Institutional Investor program, designated domestic financial institutions can invest in foreign equities and debt securities, but that appetite is subject to quota restrictions.

Even with controls in place, it hasn’t always been smooth sailing. During the period 2016-17, the People’s Bank of China (PBoC) expended roughly one trillion dollars to defend the country exchange rate at the CNY7.0/USD level, a punishing exercising and one reducing foreign exchange reserves from USD 4.0 trillion to USD 3.0 trillion. That proved daunting; the monetary authorities have subsequently aimed to keep foreign exchange holdings at the three trillion level since then. So, to keep that official level of foreign exchange liquidity steady, that presupposes a tight leash on how resident savings channel in and out of the domestic economy, and therefore what can or cannot be allowed to affect CNY value. That has to mean controls. But then, the related question is how steady or robust can those controls be? Other questions come to mind as well. Can these controls be circumvented? What would obviate the need for them? Are there policy developments in play which may allow for a more expressly market driven CNY exchange rate, eliminating the need for controls? Or simply, what could go wrong? Investors and lenders will have to think about these things.

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