![]() In recent years, the dollar’s influence has steadily declined, according to Chen Zhang of the National University of Singapore and colleagues, falling from one to about 0.3.Ĭhina might cling more tightly to the dollar in a period of great financial stress. In the dark days of 2015, it moved one to one. Economists have looked at how faithfully the yuan mimics movements in the dollar against other currencies. For this reason, the yuan now seems less anchored to America’s currency. Having taken these measures, China now seems more confident that the yuan can fall against the dollar without the fall becoming self-reinforcing. That requirement was removed in 2020, only to be restored last month. It also imposed a reserve requirement on banks that made it costlier to bet against the yuan. It introduced a mysterious “counter-cyclical factor” in its calculation of the morning fix, intended to offset any speculative momentum. To restore stability and credibility, China sold more than $700bn of foreign-exchange reserves in 2015-16 and enforced its capital controls more zealously. But from one day to the next, the speculators could move the zone. Within any single day, the zone might constrain the speculators. Thus any speculative declines during trading could be embedded in the following morning’s fix. ![]() Each morning’s fix was supposed to reflect the currency’s value at the end of the previous trading session. That did not work in China in 2015 partly because of the way its stairs were built. The mere prospect of intervention by the authorities could make actual intervention unnecessary. Knowing that, speculators would push it back to the middle. As the exchange rate reaches the bottom of the zone, its room for further declines is limited. Mr Krugman showed that target zones, if credible, could ameliorate this problem, by converting speculators into stabilisers. Expectations of yuan declines can become self-fulfilling, regardless of the underlying state of the economy. “Few will heed fundamentals.in times of turbulence and turmoil,” as Zhou Xiaochuan, then China’s central-bank governor, put it in 2016. Unfortunately, financial markets are not respectful of such calculations. If only the fundamentals applied, it ought not to plummet. It has remained stable this year against a broader basket of currencies. Adjusted for inflation, it is about 10% below its fair value, according to the Institute of International Finance. Despite its insulation from market forces, its exchange rate is reasonably well priced. It is, however, not outlawed by the impossible trinity.Ĭhina can also take comfort from the economic fundamentals. This can be inefficient and inconvenient. But China has also adopted tighter capital controls, especially since 2015. The yuan has been less volatile than India’s rupee, let alone South Africa’s rand or Brazil’s real. By imposing limited controls on capital, say, they can provide some stability to their exchange rate, without entirely forgoing monetary independence.Ĭhina has clung to exchange-rate stability more than most. Many have adopted mixed positions, embracing none of the objectives in full, nor rejecting any entirely. As Joshua Aizenman of the University of Southern California has pointed out, emerging economies are more ambivalent. Rich countries typically make clear-cut choices. A country might want exchange-rate stability, monetary independence and free capital flows, but it can have only two of these. In assessing China’s currency choices, economists sometimes invoke the “impossible trinity”. For that reason, China will try less hard to prevent it. The yuan’s decline against the dollar is now less likely to become disorderly. ![]() In the past China kept its currency anchored to the dollar, because it feared that a conspicuous drop would trigger a run on its currency. Its target zone is better managed and its capital controls are better enforced. Some analysts fear a repeat of 2015, when a poorly executed devaluation of the yuan provoked capital outflows that further undermined the currency. What is less clear is where the bottom of the staircase lies, and how sure-footed the descent will be. But tighter monetary policy would be at odds with the needs of its weak economy, which is hampered by a property slump and draconian covid controls. To stabilise the yuan, China’s central bank could raise interest rates in tandem. America’s Federal Reserve has raised interest rates aggressively to curb inflation. ![]()
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