China has stopped manipulating its currency

Mitt Romney claims that he will label China a currency manipulator on day one in office (if he wins).

Various people have weighed in already as to whether Chinese currency is still being massively manipulated, whether China is the biggest currency manipulator of all time, and whether the Chinese yuan is actually massively undervalued at this point  (see Ezra Klein’s post for more discussion).

I see it from another angle.

Many have noted that the fact that China has a large foreign reserve is largely due to China’s actions to keep the Chinese yuan cheap. With a large trade surplus and consistent capital account surplus in the previous decade, the only way to keep the yuan from appreciating too quickly is to essentially print money. In the process of keeping the yuan exchange rate cheap, People’s Bank of China had to 1) print yuan and 2) sell the newly printed yuan to CNY buyers, of which there were many. In the process of “manipulating the currency”, the central bank ended up buying a lot of foreign assets, with much of the holdings in US Treasuries. The side effect of this action to intervene in the currency market is that it expands monetary base, which means permanently excessive liquidity.

This is the story that we know too well.

However, this has changed in the past 12 months. I’ve noted that there was a dramatic change in the funds flows pattern 12 months ago. While China is still running a trade surplus, it is much smaller than pre-crisis levels. The behaviour of trading companies have changed as they seem to favour the US dollar more than the yuan as their store of value (or whatever), meaning less demand for yuan over the past 12 months. Also, the persistent and consistent capital account surplus in the previous decade has turned into a capital account deficit, which is now big enough to totally offset the current account surplus which China is still currently running.

The result of capital outflow for the domestic economy is very clear. Liquidity in the Chinese banking system is now no longer permanently excessive. In fact, liquidity conditions are right now tight and very unstable, which often requires massive PBOC injection through open market operations.

There is, however, one interesting and related consequence. We have already noted that China’s foreign reserve is no longer growing in size since a year ago.

China’s foreign reserve became this large as a result of currency market intervention as the authorities were keen to avoid the yuan from rising too quickly. The fact that China’s foreign exchange reserve has stayed more or less unchanged for around a year points to the possibility that China is really not doing much in the currency market.

In other words, China has probably stopped “manipulating” its currency for probably a year, if “manipulate” is the right word to describe it. Whether the PBOC actually intended it that way or not is another matter, as markets were expecting yuan depreciation for the best part of the last 12 months, which meant that there was no point for the PBOC to keep the yuan cheap, as that was where the market wanted to go anyway.

However, the recent strength of the yuan against the US dollar points to the possibility that the Chinese central bank is still not doing much in the currency market.

If the PBOC wants to keep the yuan cheap at this point, it would require them selling yuan and buying foreign assets, which essentially injects liquidity into the domestic banking system. With liquidity injection through foreign reserve accumulation, liquidity should have been eased whenever there is inflow, as there seems to be happening currently. However, it does not seem to be happening. Instead, the PBOC has to injects massive liquidity through open market operation in order to keep money market rates low.

Of course, this could be merely a political decision to do nothing ahead of the presidential election and let the yuan  rise. But the reality is the central bank has most probably stopped trying to make the yuan weaker (or stronger) for probably a year.


  1. Finally, even MACROBUSINESS has discovered what I saw months ago. Why did it take you folks this long to notice this ?

  2. ‘Bashing China’ is a cheap way to garner votes in the ‘Bible Belt’. Even if Romney wins, he won’t start a trade war with China.

  3. Just look at USD/RMB graph. RMB has appreciated substantially over last 2 years against the USD.(I use free version of Incredible Charts to monitor graphs of shares in multiple markets, commodities and currencies. Much quicker than on line services and I can’t justify paying for a service. Data is end of previous day.)

  4. Nope. Wrong.
    1. China had a Current Account Surplus and was enjoying a net money inflow. The PBoC absorbs those USDs. And prints the same amount of yuan because e.g. chinese manufacturers can’t use USDs in the chinese economy.

  5. You’re reading to much into it. It’s much more simple. China has no Current Account Surplus anymore and therefore doesn’t need to buy Treasuries anymore to manipulate the currency exchange rate. As simple as that. But that also means that the US government should start to worry. Just in a time when US deficits are going through the roof again.