This archive report was first published on 28 August 2019.
China's currency, the renminbi, has been a focal point in the ongoing trade war between Washington and Beijing. The currency weakened by 0.15% against the dollar on Tuesday, its weakest level since early 2008, according to data from FactSet.
Since the Trump administration began to talk of imposing tariffs on Chinese exports in early 2018, the currency has dropped roughly 10%. The decline has picked up speed in August, with the renminbi down about 4%.
Allowing the currency to weaken helps China offset the impact of American tariffs on its products. However, the drop also reflects uncertainty about what China's economy faces, as the global trading system it depends on is thrown into chaos by the trade war.
Ben Emons, managing director of global macro strategy for Medley Global Advisors, noted, 'The trading relationship of China and the rest of the world is changing. There's less demand for Chinese goods and less demand for the Chinese currency.'
Large-scale economic factors at play ¶
China does set a daily 'fixing' around which the currency can trade, but the falling value also reflects the range of large-scale economic factors that would affect any exchange rate: economic growth, interest rates, and trade balances.
China's economic growth has been weakening lately, most likely as a result of the spiraling fight over tariffs. Growth is clearly slowing, and interest rates are widely expected to fall as the government tries to keep the country's expansion alive.
The tariffs themselves are also a factor. Economic theory has long predicted that tariffs will result in a weakening currency, as they're designed to cut the exports of the country on which they're levied, in this case China's exports to the United States.
A vicious cycle can follow a falling currency ¶
The dour outlook for the economy may also be prompting some global investors to pull money out of China. More than $60 billion fled China in May and June, the last months for which data was available from the Institute of International Finance.
A weakening renminbi itself can also spur capital outflows from wealthy Chinese seeking to protect their savings from devaluation. Such outflows can be difficult to control, forming a feedback loop in which downward pressure on a currency causes more selling, as more investors rush to cash out of their Chinese investments.
China's stockpile of dollars is another clue ¶
Another clue that the falling currency isn't entirely Beijing's doing is that its stockpile of dollars hasn't been growing very much. Because China sets a narrow price range for the currency, it has to intervene in markets to keep it within that band.
Conversely, when the Chinese authorities are trying to keep the country's currency cheap, they print it and use it to buy up dollars. The result for the Chinese is both a weaker currency and a large stockpile of American dollars.
