Compounding those tensions, the results of well-intentioned but poorly executed policy decisions have been events beyond China’s control: rising global energy prices, as well as severe droughts and floods.
The prospect of China achieving its 5.5 percent economic growth target this year is remote. Most likely, the GDP growth number will have a “3” in front of it, at best.
The steady drawdown of the US Treasury stock in China is likely related to its currency and its efforts to avoid a significant depreciation of the yuan, which would be inflationary but, more particularly, could increase volatility within its system. financial and economy.
China runs a managed float for the yuan, which allows trading within a range of two percent or so, based on a daily “fix” by the People’s Bank of China. It has been notable in recent weeks that the PBOC has set that rate at levels well above market expectations – it is trying to prevent the yuan from slipping against the dollar.
Or it should be slipping more. The yuan has fallen to a two-year low against the US dollar, depreciating about 8 percent since mid-April. One dollar bought 6.4 yuan at the beginning of the year; now buy 6.9 yuan. It seems that the PBOC is trying to make sure that its currency does not go above the level of 7 yuan per dollar that it reached in July 2020 in the initial phase of the pandemic.
China’s central bank has reportedly been telling its large state-owned banks to sell, not buy, US dollars as part of its efforts to contain the yuan’s depreciation against the dollar. Reducing its US debt holdings would have a similar effect.
At this point, trying to prop up the yuan would have little to do with fears of inflation. COVID shutdowns, the housing crisis and extreme weather events have helped keep inflation in check, along with a fairly conservative response, by Chinese standards, to the slowing economy.
There have been some modest cuts in PBOC interest rates, including one last month, and some relatively modest fiscal stimulus (compared to previous packages).
Last month, Premier Li Keqiang announced 19 new economic support policies and dispatched high-ranking officials to order local governments to do more to help stabilize economic growth. The policies had a combined value of 1 trillion yuan ($210 billion).
A depreciating currency makes exports more competitive, which is why the PBOC’s efforts to defend its currency are, in conventional thinking, curious.
However, with the global economy slowing and perhaps heading into recession, China’s authorities are likely to be more focused on trying to stimulate weak domestic demand and industrial activity (reflected in weakness in non-energy imports from China). than in exports.
The raw materials for China’s economy, whether it’s oil, gas and coal or iron ore and other metals, are of course priced in US dollars, which provides another reason to try to protect the currency and, in the process, its beleaguered industrial base.
However, it is also the case that other Asian economies have become increasingly important to China itself, as suppliers, consumers and competitors.
Most other Asian currencies are experiencing further devaluations, which has increased the potential for financial instability and capital flight from the region, as economies with significant US dollar borrowing and dollar-traded commodity import exposures Americans are under increasing pressure from higher global interest rates and a stronger dollar. The region is experiencing stress from the strength of the dollar.
The US dollar has strengthened significantly. Against a trade-weighted basket of its major trading partners, the dollar has appreciated nearly 14 percent this year.
That reflects the growing divergence in US monetary policy from that of other major economies, including China.
US rates are being aggressively boosted in response to levels of inflation not seen in decades, even as China’s interest rates have been falling.
With Jerome Powell of the Federal Reserve Board stating at last week’s Jackson Hole conference that the Fed’s commitment to reduce US inflation (currently 8.5 percent) to its target of two percent percent is “unconditional,” the outlook is for US rates to continue to rise. , widening gaps with other economies setup and continuing to put upward pressure on the dollar as global capital flows to higher yields.
Defending the yuan and profiting from the sale of its US Treasury holdings in the process could be a way of trying to quarantine its domestic economy from external threats while it focuses on dealing with internal threats.
That, if the PBOC allowed the yuan to depreciate significantly and rapidly, would be a recipe for instability in China.
There have already been some outflows of foreign capital from China’s bond and equity markets, although China, while relaxing controls in recent years, still has a tightly regulated capital account.
A wave of capital outflows would not threaten China in the same way that it might destabilize other less developed and tightly regulated economies, but it could add to existing instability within China’s financial system.
China has enough problems without importing more instability. Defending the yuan and profiting from the sale of its US Treasury holdings in the process could be a way of trying to quarantine its domestic economy from external threats while it focuses on dealing with internal threats.
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