China's Real Problem: The Yuan

Lior Alkalay - Contributor - Forex

In the past few weeks, and especially this last one, equity investors watched in horror as China's stock market began to disintegrate. More than $3 trillion in value disappeared in what seems like the blink of an eye. Over the same period, the FX market has been preoccupied with the unfolding events in Greece. Many investors believe that, while Greece is very relevant to the FX market, China's problem pertain only to a bubbly stock market. If that's what you believe, too, you thought wrong! China's stock crash is a mere side effect of the country's real problem – the Chinese Yuan.

China's Ambition for the Yuan

The Yuan has always been a critical tool for Chinese policy makers. During the 1990s, China essentially sacrificed the Yuan in favor of growth as it aspired to become the world's factory. That thanks in large part was to a cheap labor force. Cheap labor is essentially only possible with an undervalued currency. The Chinese government succeeded in its endeavor. China rose to prominence, moving swiftly from a somewhat marginal economy to the world's second largest economy. There is no other way to describe it except as a phenomenal economic achievement and one skilfully executed.

China Annual GDP Growth

Now, Chinese leaders have reached their next resolution and are set to take the first step. Once again, the government’s resolve relates to the Yuan. In order to avert a Japanese style of rise and decline, China's government wants to do things differently. The government recognizes that it must turn the Yuan into a reserve currency, one that matches the dollar. This will allow China to turn into a more sustainable credit-driven economic model, à la the United States.

The Chinese government came to a great, earth-shattering realization. That realization is simply this: The reason the US can weather even the most challenging economic crisis is because the dollar is the world’s reserve currency. The greenback is so critical to global settlements that the US government can essentially borrow its way out of trouble. Of course, unlike pretty much every other country.

This intrigues Beijing; a more stable economy means a more stable government. That means the current Chinese government could secure the future of the party and thus its hold on the country. Making the Chinese Yuan a reserve currency is fast becoming a priority in Beijing. In that quest, China has made an 180-degree turn and decided to compromise growth and allow/push the Yuan higher.

Things Don't Go as Planned

China's ambition to become the world's factory and the consequent rise to prominence went remarkably smooth. Not so this time around, though. China can simply not sustain the current of the Yuan appreciation and here is why:

While the Yuan has continued to appreciate, wages in China have been rising as well. This resulted in the old double whammy for Chinese exporters. Since exporters earn in dollars their costs have been rising, first because of wages and then because of the rise in the Yuan exchange rate.

Wages vs CNY
Chart courtesy of

And after China's long, long dependence on exports for growth, this dependency can't just be waved off for a new model. The proof is in the pudding, as they say. Data shows the Chinese economy keeps slowing, inflation is quickly plunging and PMI readings are taking a nose dive. China's rate cuts don't seem to make any difference to growth or to inflation.

China PMI
Chart courtesy of

Yuan Has to Go Down

Eventually, the Chinese government will have no other choice. To soften the pressure on its economy and revive its inflation, it will be forced to resort to its old tool. Yep, once again, Beijing will have to sacrifice the Yuan in exchange for growth. The Yuan, at some point, may return to rise. At the moment, though, given an economy long "addicted" to a weak Yuan, it is going to be a tough addiction to break.

Look for my post next week.

Lior Alkalay Contributor - Forex

Disclosure: This article is the opinion of the contributor themselves. The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. This contributor is not receiving compensation (other than from for their opinion.

5 thoughts on “China's Real Problem: The Yuan

  1. Since long, China is going to provide some tough but interesting as well important lessons, which are will be taken place in History of Financial Structuring and Economy related Political decisions, and we and our future generation will learn or understand certain consequences thereof, and we will also learn some grass root principals, linked with Growth Sustainability on constant and long term perspectives.

    To settle real estate bubble, they have encouraged Stock market in"Never Before Style" which is purely or fully Government supported. Ultimately that idea turned in to one more bubble, and now they are trying to flew more air to protect or to inflate that bubble. This so clear situation that No any further illustration therefore, required to explain that What will be the most probable outcome, Whenever any such wrong theory is adopted to correct preceded wrong theory.

    As far as Valuation or Exchange rate of Yuan is concerned, either Stronger or Weaker Yuan, within such both scenario, being an end results, just Type of Damages will be changed, because there are many complex factors coupled along-with. So as per my personal view, Yuan must be keep Market Driven only, without applying any kind of artificial or fabricated measures, unless and otherwise situation may turned even more worst.

  2. Sir, can u tell us why did chinese GDP drop from 15% in 1995 to 2.1% in 1996. I have never read such extreme values in Gdp for any nation. Is it a typo error ? If not what were the reasons ?
    Also with loss of 3 trillion$ in stock market values how much of that would translate to real loss ? Would it be 300 billion $?

      1. Hi Mahesh, Rasesh,

        Thank you for your excellent question. The reason for this sharp slowdown in Chinese GDP is the Asian currency crisis that erupted in 1996 but officially erupted in 1997. This was the most severe economic crisis in Asian economies in the past 30 years. Asian countries such as Thailand and Malaysia have become insolvent and were on the verge of bankruptcy. This of course has a strong impact on Chinese growth although less than its neighbours.

  3. In December 1948 the Peoples Bank of China was established as China’s Central Bank and Treasury. When Chiang Kai-shek left China and settled in Taiwan, he took all of China’s gold from its Treasury. This left China’s Treasury without any gold, and from that time, China has been acquiring its current gold hoard from its financial savings.

    No country that has debt-based currencies can politically reset their own economy by their own current government. Their currencies must become asset-based for sustainability. This is because gold and gold-backed Chinese Yuans are Assets, and there is no limit on acquiring Assets, as there are limits for acquiring debts or Liabilities. That means that all current governments that have debt-based economies must be totally replaced with new personnel. Like China in 1949, the People’s Republic of China (PRC) started from zero.

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