Having shot up since the middle of last year, the Chinese currency has driven to its strongest level against the U.S. dollar in 18 months. The yuan has been remarkably one-directional, and appears set to continue strengthening.
The yuan is up 9.4% since the start of last June. At C¥6.46 to the U.S. dollar, it is well on its way to its strongest-ever level, when it came close to breaching the C¥6.00 mark in mid-2014. It stood at C¥7.14 at the end of May.
The gains magnify, in local currency terms, the effects of a stock market rally that saw the benchmark CSI 300 index advance 27.2% last year. An almost double-digit boost on top of that is nothing to scoff at.
The overriding factor is the continued strength of the economic recovery in China. Despite Wuhan - a central transit and industrial center that's roughly equivalent to Chicago - being the epicenter of the Covid-19 outbreak this time last year, China has got back on its feet economically far faster than expected.
This time last year, reports of the virus started to surface, shortly before the Lunar New Year. After the holiday, when millions of people traveled domestically and internationally, the virus hit in earnest, and the Chinese economy quickly ground to a halt. Shuttered stores and ghost-town streets became the norm.
Here in Hong Kong, we expected a devastating effect, both in business and personal terms. I'm not advocating the draconian lockdowns and total curtailment of personal freedoms that China deployed to combat the virus. But they did curb the virus, at least if you believe Beijing's official figures on infections. So too did the Communist Party's demand that factories resume production, whether management thought it was safe for workers to return or not.
For 2020, China's 2.1% growth in GDP was better than any other major economy in the world. Now it appears set for a 9.0% rebound in 2021, according to Nomura, which would spur the recovery in surrounding nations in Asia.
Unusually, Beijing appears perfectly happy with a stronger yuan. The benchmark interest rate stands at 3.85% at a time that most developed nations are keeping rates around zero. That encourages investors to put money to work in China, and benefit from higher yields, encouraging them to buy yuan assets in the process.
The traditional weakness of the yuan has been a perpetual problem in Washington. By keeping its currency low, China has been able to ensure its manufacturers are able to offer low prices internationally. A weak currency also makes it harder for Chinese consumers to buy U.S. goods.
The Trump administration in August 2019 labeled China as a currency manipulator, a move President Trump had long threatened to make. But it reversed course in January 2020, a major concession shortly before China signed the Phase 1 trade deal with the United States. The transactional nature of the Trump decisions shows that both the United States and the Chinese government were making political capital out of the yuan.
Some of the yuan's recent strength is relative. The U.S. dollar has been weakening at the same time that the Chinese currency has gained. The yuan is little changed now from its rate against the euro last June, while the euro has also gained 9.9% against the U.S. dollar since then. Dollar weakness looks set to continue as investors move money out of safe-haven currencies, and into riskier assets, emerging markets such as China being a prime destination for newly confident asset managers and owners seeking higher returns.
But in times past, Beijing would certainly take steps to counteract yuan strength, particularly against the U.S. dollar. The United States is China's largest trading partner, and was the destination for 16.8% of all Chinese goods sent around the world in 2019. A stronger yuan threatens that flow, and also makes it more expensive for U.S. manufacturers who had been making use of China as "factory to the world."
The stronger yuan advances two ambitions of the Beijing government. Beijing wants to encourage the development of the domestic consumer economy in China. Greater purchasing power lowers the sticker price on imported goods. Beijing is also terrified about currency outflows out of China, with most wealthy people doing their best to shift a large portion of their strongbox contents out of the grasp of the Communist Party. A weakening yuan had only encouraged the outward flow of assets.
Then there's the feel-good factor. Most politicians consider it a sign of strength to see their currency advance. China is also keen to encourage the international use of the yuan, which is hamstrung by China's strict currency controls. But the yuan will become more popular if it continues to deliver gains for holders of yuan assets.
Lastly, a stronger yuan is a subtle signal to Washington. Not having currency manipulation as a distraction could encourage incoming President Biden to take a more conciliatory tone on trade. Biden has said he'll prefer diplomatic alliances as a way of curbing China's rights transgressions and rising militarism, and will review the tariffs put in place by his predecessor. Yuan strength makes it more likely the most punitive tariffs, which ultimately lead to higher prices paid by U.S. consumers, may be lifted.
