Why China Can't Free the Yuan
By some measures, China has braved the storms buffeting its currency. The yuan is up 4 percent so far this year, and foreign-exchange reserves are up by $70 billion. State media has even called for relaxing capital and exchange-rate controls. But that would be like a sick person who stops taking his medicine when he feels better: The underlying conditions haven't really changed.
After China's surprise currency devaluation in 2015, it was reasonable to expect significant pressure on its reserves and the yuan for the foreseeable future. As recently as January -- with the Federal Reserve tightening monetary policy, and China's reserves hitting their lowest level since 2011 -- it seemed safe to assume that a rising dollar would hit China hard.
But a funny thing happened on the way to the yuan's collapse. Even though the Fed has raised interest rates three times since December, the dollar has fallen by 8.4 percent. This has in turn propped up the value of the PBOC's reserves while allowing the yuan -- which has a soft peg to the dollar -- to rise. The dollar falling faster against global currencies than the yuan gently pushed the yuan up against the dollar.
China's government also stepped in aggressively. Regulators cracked down on all types of capital outflows, threatening penalties on property investors and blocking companies from making foreign acquisitions. The PBOC is widely thought to have intervened in currency markets to keep the yuan priced within a predetermined range. It also introduced a new "counter-cyclical" pricing measure designed to reduce the yuan's volatility against the dollar. The much-touted effort to make the yuan a major global currency has been all but shelved.
The result of all this is higher reserves and a stronger yuan -- even though the underlying dynamics haven't changed at all. China's citizens still want to move their money overseas. They're buying up property from Bangkok to London. With a lack of promising domestic investment opportunities and some of the most expensive real estate in the world, that's not surprising.
Corporations still want to get their money out, too. Whether by repatriating profits, going on acquisition sprees, or investing in the government's "Belt and Road" infrastructure plan, they're taking China-based capital and investing it in other markets. Although official foreign investment has fallen by 67 percent thanks to stricter regulation, the ratio of bank payments for imports to customs-recorded imports -- which bottomed out last year -- has been inching back upward, indicating disguised outflows.
Wanting to liberalize the yuan because it achieved stability after all these measures makes no sense. Before it can consider a liberalization, China needs to address the reasons that companies and people are trying to move capital overseas. Assets such as real estate, where most households keep their wealth, remain very expensive by global standards, and people have an enormous incentive to move real estate capital gains offshore. The government has to do more to maintain price stability for a sustained period, including strengthening its crackdown on property speculation.
Keeping corporate cash at home will probably be harder. Companies will continue looking abroad for opportunities as long as China has widespread surplus capacity, opaque regulation and markets saturated with capital. The government needs to follow through on its promises to deleverage and do more to depoliticize financial markets. Ironically, China's restrictions appear to be harming its ability to balance capital flows: Foreign investors, hesitant to see their money go through a one-way door, have reduced direct investment by 5.5 percent this year.
In the long term, it's true that China will need to relax restrictions on its currency. But first it needs to fix the problems that made them necessary in the first place.
This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.
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Timothy Lavin at email@example.com