The curious case of China's falling yuan

A 100-yuan banknote against the background of a US dollar sign China's central bank is probably reminding traders that the yuan is not a one-way bet

The Chinese currency has had its biggest one-day fall, down nearly 1%, and has fallen 1.5% for the past week and a half. It is the biggest decline since 2005 when it introduced its new currency regime and moved away from a tight peg against the US dollar.

Dropping to 6.1 yuan to the dollar, the currency has broken a long-term trend of appreciation. Recall that it had been around 8 yuan to the dollar in 1994 when the exchange rate was set up.

The Chinese central bank, the People's Bank of China (PBOC), is right in that these are not big moves in the foreign exchange market. In a statement, the PBOC says this volatility is normal for other economies so there's "no need to over-interpret it."

But since the Chinese currency is controlled by the central bank to move within a narrow band of 1% around a daily fix and isn't convertible, the breaking of a steady trend will be viewed as a signal.

So what is the central bank signalling? Probably that the yuan isn't a one-way bet, meaning that the currency can fall as well as rise. It matters in that if traders expect the currency to always rise, then they will increase demand for the yuan that produces the intended effect.

As China wants to control the pace of appreciation, it ends up having to intervene to buy dollars and there's not a huge appetite to buy even more dollars as China holds rather a lot already.

Long-run value

There's also appreciation pressure from the demand for yuan as capital continues to flow into China, despite slowing growth, or perhaps because of it, since investors seem to like steadier and more balanced growth.

By demonstrating, or rather orchestrating, that the currency can fall as well as rise, the central bank is trying to show the currency isn't a one-way bet, since that can be self-fulfilling.

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Reading the tea leaves, a bit of volatility is likely what the Chinese central bank is after”

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The central bank may also see the yuan as being close to its equilibrium value, so there shouldn't be too much upward pressure or the currency could end up being over-valued and that would hurt exports.

Of course, it's not possible to say what the long-run value is due to a number of reasons; China has no market-clearing interest rate (it has several benchmark lending and deposit rates), the currency isn't tradable across China's borders, and inflation isn't well-measured.

So it's difficult to make what economists call purchasing power parity (PPP) estimations, that essentially says that goods should eventually cost the same across countries, so exchange rates offset pricing differences. Well, that's hard to work out for most countries which is why the short-run exchange rate can be volatile.

Reading the tea leaves, a bit of volatility is probably what the Chinese central bank is after. The internationalisation of the yuan is underway where the Chinese currency is now traded in offshore hubs such as London.

According to the global transaction services organisation, SWIFT, the yuan is already the seventh most-traded currency in the world, after the highly liquid top six currencies, rising quickly in just a couple of years. And this is without it being tradable or convertible.

So the exchange rate reforms are gaining speed. The PBOC has a plan to allow the currency to be liberalised within the decade, and the Shanghai free trade zone is experimenting with allowing the yuan to be traded.

Steady rise

For these reforms to work, they wouldn't want speculators to push up the value of the currency, so the PBOC is flexing its muscles to show that it is in control and what it wants is for the currency to move up as well as down.

It is hard to bet against a central bank - whether it's the Chinese or the Swiss. But for now, most economists still expect that the yuan will continue its steady rise as the economy continues to grow.

The PBOC could find that it is working against the fundamentals of the economy so it probably won't try and depreciate the currency by much, but it is well able to intervene and make it move up and down on a daily basis.

Linda Yueh Article written by Linda Yueh Linda Yueh Chief business correspondent

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  • rate this

    Comment number 27.

    Hi Andy. I think (I could be wrong) that you and I are more on the same page than you realize. Personally, I would judge that my written communication skills are limited to within their intent. Personally I see little need for progression, other than to try to help a greater proportion of those that need it, which (as you I believe you correctly imply) will become a greater future problem. Ho-hum.

  • rate this

    Comment number 26.

    In China's case billions of real people.
    Global effect - 7 billion.
    How long do you give communism in China, in its current form?
    Great experiment. With the ageing problem and the lack of pension provision globally China will be competing with us for immigrants soon. Unless pollution gets them first.

  • rate this

    Comment number 25.

    But ON topic.. Current China is a fantastic example in academic context regarding the nature of capitalism. It's magnitude and position make it about as close to a restricted major progressive system that the real world can realistically produce, and as such it may well feature in future economic textbooks. I suppose it also concerns the genuine plight of many millions of real people.

  • rate this

    Comment number 24.

    Staflation/deflation is as sure as night will follow day, or, the alternative of high inflation.
    Depends on the positioning of the printing press.
    Either way the future is not looking positive. For either investors or the people.
    Who wins?
    The people will decide eventually......
    When the hubris reverses :)

  • rate this

    Comment number 23.

    It's sad that the mental position of the nations average commentator is so passionately negative that the bbc feel they have to limit public hosted discussion to minor temporal stories. A week of decline during the greatest economic expansion of the age! I propose a cull on MP's for spreading mental disease through the nation, I have no scientific reference but apparently that doesn't matter ;)

  • rate this

    Comment number 22.

    I don't think we need worry about Sovereign debt, do we?
    Effects of printing can be
    1) Inflationary (if sufficient demand for goods)
    2) Stimulate economies, prevent stagnation
    3) Devalue currency (make imports more expensive, exports cheaper).

    So, what's the problem (unless you have a lot stashed in a tax haven)?

  • rate this

    Comment number 21.

    3. DemoDave

    Indeed. Does anyone really believe their figures?

  • rate this

    Comment number 20.

    Is China buying more T-Bonds with its trade surplus?

    Is that why the Pound is on the up?

  • rate this

    Comment number 19.

    Tick tick boom!
    Or is that the presses working tirelessly.

    Someday the World will wake up to this constant printing and realise it is poorer every year through inflation.

    Welcome to the 1970's again.
    Lib/Lab pact next anyone?
    2019 is going to be some fun year :)

    We all walk blindly into the valley of death - the contagion of economic ignorance.
    DEBT DEBT DEBT everywhere...

  • rate this

    Comment number 18.

    The value of the Yuan has been false for as long as I can remember, any rise or fall is 99% political and % market driven. Anyone who puts faith in Chinese economics in the normal manner is seriously deluded.

  • rate this

    Comment number 17.

    Costs have been rising in China particularly as wages improve. Of course they are improving slowly from being very low but it is better than a poke in the eye with a burnt stick.
    I hope that China will improve conditions and wages for everyone and deal with the endemic corruption.
    The same applies here as well.

  • rate this

    Comment number 16.


    Not so much a matter of export costs rising but global (primarily western) demand falling off a cliff. The attempted fix has been to 'westernise' China, making it more consumerist, thus replacing external with internal demand.

    Given the starting point for Chinese consumers, quality of goods is, so far, almost an irrelevancy. As you say, it's about keeping factories open.

  • rate this

    Comment number 15.

    It is not so much a case of encouraging domestic demand but export costs have risen. Most serious manufacturer's are still in play with improved quality but the more opportunist entrepreneurs have been wiped out.
    There remains the need to keep orders flowing through the factories so that people are employed. Gradually China is becoming a quality manufacturing source. Being cheap solves nowt.

  • rate this

    Comment number 14.

    The curiouser case of the disappearing Bitcoins

    The Bitcoin cull is far more interesting.

    The business was named after a famous......GAME, you know.

  • rate this

    Comment number 13.

    Did I hear someone say currency manipulation?

  • rate this

    Comment number 12.


    I get the implession that since 2008, they've been hard at work trying to encourage domestic demand, i.e. reduce their dependency on exports, not to mention their holdings in dollars.

    Pollution was higher on eveyone's agenda before the crunch. Then it became about rescuing economic failures. Not orchestrated I suppose, but convenient. We need the US on side, and China will follow.

  • rate this

    Comment number 11.

    @7. Forex traders said they think it is to scare off speculators who have been backing the rise.
    Let me guess, the 'bonus brigade' boys & girls are @ it again! Just as well Mao aint in charge any more, cos he might just have redirected their efforts towards rice fields, on the premise they'd be doing something USEFUL for a change!

  • rate this

    Comment number 10.

    I am not surprised. My wife is Chinese & her family in Beijing have seen some bad tumbles in some funds which have been geared to property deals & construction; a sector which has been a sure bet for 3-4 years. It made me think of Pestons' programme last week.
    It may take a while for Beijing to get control of the runaway train of property development in China but maybe it's starting.

  • rate this

    Comment number 9.

    The Chinese are hard at work unwinding a credit bubble before it becomes critical. I wish them luck. The hot money is now running away: good riddance. That can only be to China's benefit.

    Perhaps growth will slow down but then by reducing the value of the yuan this can only help domestic industry to export.

    A priority in China must be to clean up the pollution.

  • rate this

    Comment number 8.

    @7 Brian
    Yes perhaps they could flush out some of the aggressive longs that way.
    I rather think though that the main problem with the hot money is on the short side (in selected stocks)


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