Will China Retreat Into Itself?
It’s never easy to gauge what exactly is happening in China, or why the CCP Politburo takes the decisions it does. Today, or overnight, is no exception to that. However, one thing that appears certain, but which I don’t see reflected in all the analyses, is that Beijing pushing the value of the renminbi (yuan) down below 7 to the USD in one fell swoop, is a major setback for Xi Jinping and his government.
Yes, China may have given up hope of reaching positive conclusions in its trade talks with the US. And yes, some may think, even in China itself, that devaluing the currency is a tool that can be useful in a potential currency war. But there’s another side to this coin. It’s not even about the value itself, or the change in it, it’s the heavy-handed way it’s executed.
China wants, and desperately needs too, for the yuan to be a force in global financial markets. In very simple terms this is true because if it then wants to buy something, it can simply print the money for it. But only about 1% of global trade today is executed in yuan. That is not nearly enough. It means China needs dollars and euros, all the time. And devaluing the yuan means the country needs even more of those.
You’d almost think: why would you want to do that? What are the long-term prospects for a move like this? You’re telling forex markets that the value of the yuan is not trustworthy, because if Xi or the PBOC decides in the next five minutes that it should go up or down by 10% or 20%, they can do it. The Fed and ECB also have tools to manipulate their currencies (re: interest rates), but none of that magnitude.
The crux of the dilemma probably lies in the Belt and Road Initiative (BRI), which I’ve been saying for years is just China’s way to sell its overcapacity and overproduction abroad. Sure, there may be loftier goals, and surely in the glitzy brochures, but the fact remains that China has tried to be an economic miracle, doing in 10 years what took the US a century, and it never slowed down its growth, at least not voluntarily, even if that might have been a wise move.
Already lately, purchases by Chinese citizens and companies of real estate and businesses abroad have been curtailed, and not a little bit, by Beijing. There’s no better way to convince Chinese people of the miracle’s success than to let them travel the world and spend there, but that, too, may well soon be cut. It kills foreign reserves.
If Beijing could charge participating countries in the Belt and Road Initiative in yuan, and they could pay for the overcapacity’s steel and cement and what not in yuan, that could be a game-changing program for the entire planet. But these countries have no reason to hold yuan, other than the BRI itself. And they, too, were watching the overnight move above 7 and must have thought: let’s be careful now.
And to top it all off, China right now needs for these countries to pay in dollars instead of yuan, because its foreign reserves are shrinking so fast. It’s Catch-22 all the way down. China’s need for dollars goes against everything BRI stands for.
Could the move hurt the US as well? Absolutely. But the long-term view behind the tariffs, and the talks China appears to have lost faith in, is to move the US away from its near all-encompassing addiction to Chinese production, and to move at least some of that production back home. Problem of course is, that is precisely what China’s miracle growth has been built on.
If the US starts bringing production home, who is Beijing going to sell its (over-)production to? Yes, I hear you, to the BRI countries. But there it runs into the currency problems mentioned before. To Europe? The top of that trade route is also behind us. Europe will have to follow the US to an extent, and also bring factories back to the continent (and not just to Germany either).
China could perhaps sell more than it does today to Russia. But that country still does produce a lot of things, and has been forced to be much more self-sufficient due to US and EU sanctions. It’s also a mighty small market compared to 350 million North Americans and 500 million Europeans, who are on average much richer than your average Russian to boot.
There is a way for China to make the yuan more important in global trade (but devaluation is definitely not that way): Beijing could let go of its central and total control over the value of its currency, and let forex markets figure it out. That would give traders -and everyone else- faith in the value. Problem with that is, this is not how central control communist governments think.
Beijing wants both: central total control AND a prominent place in world trade. And it may take them a long time to figure out that is not going to happen, unless of course they first conquer the entire world militarily. That is not an option, at least not for the foreseeable future. Come see me next century.
It wouldn’t be the first time for me to say I can see China retreat into itself, into its own borders and culture and market (1.3 billion people!). If the Communist Party wants to remain in power, and there’s no doubt it does, this may be only possible choice going forward. If growth has indeed left the miracle -as many observers think-, it can implode in very rapid succession. And even if growth hasn’t yet evaporated, it may well very soon. Without the growth, there is no miracle anymore.
And if China can no longer grow its exports, its domestic growth will also become a thing of the past. Domestic consumption can only grow as long as exports do too. Seen from that angle, the problems with trade and the currency look downright ominous. If you need dollars that badly, and you notice that you’re already getting fewer of them, not more, you’re in trouble.
Devaluing your currency may afford you some temporary respite, but it can’t possibly solve your troubles. It can make them much worse though.
I think China has wanted too much too fast, got carried away and forgot to take care of a few potential barriers to its growth, in particular the standing its currency had and still has in the world, and the grinding need for dollars that stems from it. And the Communists have no answer to this problem.