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Comment: China has secretly struggled to stabilize the yuan



BEIJING: At the beginning of August, the yuan's exchange rate broke through the psychological threshold of 7 yuan per US dollar.

While investors were still digesting the full meaning of this incident, US President Donald Trump's administration upset the market by labeling China is a "currency manipulator".

The term is, to say the least, absurd, because China does not meet the US government's own criteria for being a currency manipulator. In fact, the decision by the People's Bank of China (PBOC) to allow the yuan to fall below $ 7 per dollar has little to do with trade or currency wars.

Rather, it represented an important step by the PBOC towards reforming China's inflexible currency regime.

CHANGES UNDERWAY SINCE 2003

Admittedly, the PBOC intervened for a long time during the foreign exchange market. For example, during the Asian financial crisis of 1998, it adopted a de facto stick of the yuan to the US dollar, which was a key factor in restoring the stability of the region's financial markets.

After 2003, the PBOC intervened to prevent the yuan from appreciating due to fears that a stronger currency would hurt China's growth. The Chinese authorities degenerated the yuan from the dollar in 2005.

And after a temporary reconnection during the global financial crisis in 2008, China adopted a currency exchange regime in 2010 that the International Monetary Fund classified as a crawl-like arrangement.

EARLY STRUGGLES TO STABILIZE THE YUAN

However, since the end of 2014, the price strength of the yuan has declined.

In August 2015, the PBOC tried to take a decisive step from a soft knock to a floating exchange rate regime by declaring that the central parity of the yuan's exchange rate against the dollar would be determined by the previous day's closing rate.

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  FILE PHOTO: Man sitting in front of People's Bank of China, Central Bank

A man sitting in front of People's Bank of China (PBOC), Central Bank, in Beijing, China 17 October 2013. (File photo: REUTERS / Kim Kyung-Hoon)

Unfortunately, due to the poor timing of the move, the market reacted and the yuan fell by 3 percent against the dollar in three days. Without telling the experience, the authorities quickly abandoned the reform.

The PBOC then struggled to stabilize the yuan's exchange rate and in less than two years spent a billion dollars on foreign exchange reserves to support the currency.

Some economists criticized the bank for destroying reserves to facilitate capital flight and liquidation (where investors borrow money in a low interest rate currency to buy assets at a higher rate of return).

However, most supported the intervention on the grounds that it prevented the yuan from falling free and causing a financial crisis.

A BREWING DEBATE

Early 2017, the yuan approached 7 yuan per dollar, sparking a debate over whether the PBOC should allow the currency to fall past this point. Then 7 yuan to the US dollar became a psychological threshold.

Each time the exchange rate approached this level, the PBOC would set a central parity price for the yuan that was above the market rate, signaling that it would not allow the currency to fall below 7 yuan. [19659002] More often than not, market makers adjusted bids and bid prices in line with PBOC's future guidelines, and depreciation pressure eased.

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  FILE PHOTO: Chinese 100 yuan banknotes in a counting machine while a clerk counts them at a branch

Chinese 100 yuan banknotes are seen in a counting machine in Beijing, China, in this file image on March 30, 2016. (File photo: REUTERS / Kim Kyung-Hoon)

In early August, the yuan fell again after the Trump administration announced plans to impose a 10 percent tariff on the remaining $ 300 billion Chinese exports to the United States that were not taxed.

However, on August 5, PBOC did not set a higher central parity price for the yuan as the market expected.

Investors took this as a sign that this time the central bank would allow the exchange rate to break the 7-yuan-US dollar threshold, which it duly did.

SHACKLES HAVE COME OFF BUT WITH CONTINUED CONTINUES

Why did the PBOC choose this moment? My understanding is that it has been planned for many years to shake off the shackles from the yuan's flexible currency regime.

After postponing the move time and again, it had to take a decisive step at some point.

When the opportunity presented itself recently, the PBOC presumably believed that it could drop the yuan without causing significant damage to the Chinese economy.

Although the PBOC's gamble seems to have paid off so far, Chinese politicians are still concerned about excessive depreciation.

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  FILE PHOTO: Illustrative photo of US dollars and yuan banknotes in China

USD and yuan banknotes in China are seen in this illustration June 2, 2017. (Photo: REUTERS / Thomas White)

In recent days, the PBOC has again attempted to support the currency by issuing yuan bonds in the offshore market and using the countercyclical factor to set the yuan / dollar exchange rate higher than one level in line with the predetermined central parity pricing rule, to signal the preference for a stronger currency.

To those who have argued g for decades in favor of a quick transition to a free-floating exchange rate regime, these recent interventions are another sign of official dithering.

THE WRONG FIGHT

In general, policy makers should let the market determine the yuan's exchange rate as much as possible, regardless of whether the currency is moving up or down.

READ: Comment: A weaker yuan and how China reminded the United States of the economic arrows in the quake [19659046] At the same time, they should never allow a competitive devaluation of the yuan in order to gain a trade advantage. It would not only be unfair to China's trading partners; it would also undermine the country's own long-term interests.

Therefore, by accusing China of currency manipulation, the Trump administration has clearly chosen the wrong match. At least on exchange rates, its ignorance is astonishing.

Yu Yongding, a former president of the China Society of World Economics and director of the Institute of World Economics and Politics at the Chinese Academy of Social Sciences, served on the Monetary Policy Committee of People's Bank of China from 2004 to 2006.


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