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62 objectives largely remain the same: stability both economically and politically, at home and abroad; strategic uncoupling from the United States; grow domestic economic strength.
4.4 China’s Monetary Policy after 2014
At the beginning of 2014, the renminbi began to depreciate as Figure 4.1 illustrates. In late February a fourteen-year appreciation turned around and began a slide that the Chinese government has taken measures to manage.
This change is was both a shock to China’s domestic economy as well as the world economy, and analyzing what happened as well as the Chinese response is the purpose of this case study, especially as it pertains to China’s real economic coercive capabilities. First, the steps China has taken since the renminbi’s turnaround:
Figure 4.1 RMB Exchange Rate. World Bank World Development Indicators, 2016.
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Feb-25 2014: People’s Bank of China makes decision to set sequentially lower reference rates, and intervenes in the spot market to weaken RMB (Affairs, 2014)
Mar-17 2014: China widens the trading band to +/- 2 percent (Holodny, 2016)
Aug-11 2015: China adjusts exchange rate devaluing the renminbi by nearly 2
percent. Currency falls 1.8 percent its biggest fall since China establishes currency market. (Lu & Sweeney, 2015)
Sept-10 2015: Foreign central banks and sovereign wealth funds are allowed to enter onshore currency market (W. Zhang, Cao, & Yeung, 2015)
Sept-11 2015: State Administration of Foreign Exchange will conduct checks on
firms’ foreign exchange buying to prevent speculation on renminbi depreciation and prevent illegal cross-border money transactions (Lu & Sweeney, 2015)
Nov-30 2015: CNY included in IMF Special Drawing Rights (IMF, 2015a)
Dec-11 2015: New trade-weighted CNY index introduced measuring renminbi against basket of currencies (Wei, 2015)
Dec-25 2015: AIIB articles signed by representatives from 57 countries (AIIB, 2015)
Jan-1 2016: Foreign exchange reserves fell $512.7 billion in 2015 (Noah, 2016)
While in no way exhaustive this timeline highlights the key points and facts of the Chinese government’s monetary policy making. What they all have in common is an emphasis on stability and departure away from the dollar.
The first of these events is the most confounding as the trigger for renminbi depreciation was Chinese made. Indeed, right after the move to depreciate the renminbi many analysts claim
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64 that it was a move to bolster newfound investments into China hoping companies would buy in while the renminbi was, momentarily, low. However, this was more of a move to yield to economic factors. After “18 months of sustained appreciation” the renminbi began to slide lower.
The signs leading this adjustment are two-fold. first, China’s economic slowdown, while not great – only 7.7% to 7.4 % - it created many problems in the financial and banking sectors.
Consumer price inflation had already dropped significantly, undermining the ability for companies to make profits on domestic consumption, something that was a high priority for a more sustainable and autonomous development model. If domestic profits slumped as a drop in consumer price inflation dictated that model would be impossible to achieve (Economist, 2015).
Second, China’s high foreign direct investment inflows since 2009 were unsustainable, and largely a symptom of low or negative interest rates being pushed in Japan, Europe, and the United States, and of an artificially high renminbi that benefited from promises of stability.
According to a Report to Congress on International Economic and Exchange Rate Policies:
For more than a year, market participants – particularly Chinese firms operating in both the onshore and offshore markets – had been able to profit from the combination of high domestic RMB interest rates, low dollar borrowing rates, and a steady and predictable pattern of RMB appreciation. In fact, China’s exchange rate volatility declined last year, with inter-day and intra-day movements of the RMB getting significantly smaller during the third and fourth quarters of 2013. Expectations of continued low volatility created a clear incentive for firms to borrow dollars at low interest rates and invest the funds in China, which fueled the large capital inflows. (Affairs, 2014)
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65 Meaning, of course, that the promise of low volatility couldn’t be kept after the faucet on inflows was turned off and the high liquidity this provided the market was lost. Namely, when talk of interest rate hikes began in the United States and economic prospects were looking up elsewhere, the first of China’s capital outflows began.
Again, from one perspective this move to change the renminbi’s reference point allowing for the depreciation of the renminbi is a confounding one, but it needn’t be regarded as
predatory. This would be a misinterpretation of the facts, while some saw it as a deliberate move to depreciate the renminbi, artificially boosting growth and undermining Western
economies, the renminbi was not under-valued as they claimed, but artificially high. While this was a move in response to symptoms caused by policies of “quantitative easing” and low interest rates in Western economies it certainly wasn’t with the intention of starting a currency war.
Indeed, Rickards argues that if there were the beginnings of a currency war it had started at the hands of the United States:
Quantitative easing could be used by the Fed not just to ease financial conditions in the United States but also in China. It was the perfect currency war weapon and the Fed knew it. Quantitative easing worked because of the renminbi-dollar peg maintained by the People’s Bank of China. As the Fed printed more money in its QE programs, much of that money found its way to China in the form of trade surpluses or hot money inflows looking for higher profits than were available in the United States. Once the dollars got to China, they were soaked up by the central bank in exchange for newly printed
renminbi. The more money the Fed printed, the more money China had to print to maintain the peg. China’s policy of pegging the renminbi to the dollar was based on the
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66 mistaken belief and misplaced hope that the Fed would not abuse its money printing privileges. Now the Fed was printing with a vengeance. (Rickard, 2011, p. 135)
Therefore, who can blame them for taking preliminary measures to combat the negative inflation this caused. It was less of an act of coercion than it was an act to preemptively combat an
excessively high renminbi evaluation that was having negative effects on the domestic economy.
This along with the widening of the trading band to +/- 2 percent, doubling the allowed movement it had against the dollar, while still maintaining the peg weren’t big enough move to have eliminate the over-valuation and more actions were necessary. However, such moves were impeded by continued threats of capital flight. It has long been the rule of thumb that ordinary people were not allowed to convert more than $50,000 worth of Chinese renminbi into foreign currency per year, and this remains true. However, Chinese officials have made it harder to convert even that much, and citizens and business people alike have moved to circumvent these rules (Hewitt, 2015). Essentially, China finds themselves trapped in an economics problem involving the impossible trinity. “They cannot achieve a stable currency, the free flow of capital, and an independent monetary policy all at once. Since China has tightened its control on capital, it now much choose between stability in its currency or its monetary policy” (J. Zhang, 2016). It is clear that China needs the free flow of capital into the country, but it can’t abide the free flow of it out; furthermore, to contend with its largest short term and long-term objective of ascending to IMF Special Drawing Rights China is required to allow greater market forces to come to bear in its currency evaluations.
As China battles with its priorities the capital continues to flow out. What started in 2014 has increased through 2015 and 2016. Attempts at stemming it such as the State Administration
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67 of Foreign Exchange (SAFE) conducted checks on financial firms’ compliance to regulations, or attempts at counteracting the outflow by encouraging greater inflows like those that took place in September 2015 have done little to alleviate the problems capital flight presents. The earlier theoretical model of monetary power and China’s vast reserves as a tool of economic coercion don’t take into account the dangers of capital flight. These dangers are especially poignant in China’s case as it needs the liquidity to support greater development and domestic consumption.
Now beginning our third year of capital outflow growth some are very worried even as SAFE officials say “China’s capital outflow has moderated a lot and it will move towards balance in the future” and “the current reserves are adequate” (F. Tang, 2017). Official totals of capital flight has been daunting, but those are also misleading since it doesn’t take into account those under reporting true export income, buying online decentralized currency like bitcoin, or literally capital flight as citizens fly money out stuffed in their luggage; furthermore, not all of China’s reserves are immediately on hand a lot of them are “tied up in illiquid assets” such as natural resource rights and the Asian Infrastructure and Investment Bank (Lopez, 2015). It is redefining or perhaps revealing the role that vast reserves can really play in economic crisis or economic coercion, “Adequacy of foreign reserves is an outdated concept from the days of the gold standard” (VanDerKamp, 2017). It would appear as though, the power of reserves is greatly exaggerated as a tool of economic coercion, but it may also be mute in terms of economic distress.
Throughout and despite the fears of capital flight, China’s resolve to obtain IMF special Drawing Rights remained absolute. So, on August 5, 2015 when the IMF published their report that China still had significant work to do to achieve Special Drawing Rights status, China got to work fulfilling those requirements (IMF, 2015b). The move that gained the most discussion and
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68 coverage was the August 11, 2014 readjustment. In comparison to the .7 percent adjustment in the reference rating that took place in February of the previous year, the August 11th adjustment was indeed quite a bit larger at 1.9 percent dropping the renminbi 1.8 percent (Lee & Chen, 2015) falling just over 3 percent in three days (Yan, 2015).
Again, and with the background of a higher audience, fears of a currency war spread pitting the United States dollar and the Japanese yen against the renminbi (Ryan, Inman, &
Farrer, 2015). These call were misguided though, as many called the move a depreciation to spur exports and aid a struggling economy, the reality was actually much more complex. What many called for – a more market oriented evaluation of the renminbi – was exactly what the People’s Bank of China was trying to give to meet IMF standards for Special Drawing Rights.
Since the People’s Bank of China sets the day to day value of renminbi, it can be easy to understand why there was a feeling that this was a deliberate move to at worst undermine
economic activity and currency valuations in other countries, or at best a way to artificially boost exports (Economist, 2015). In reality, it was an attempt to have a one off change in renminbi valuation while at the same time moving the renminbi away from its peg on the dollar and allowing the market to play a greater role (China's Currency Devaluation, 2015). The move was away from the old system of “central parity” wherein the renminbi could trade at a value plus or minus 2 percent of the central rate that the People’s Bank of China chose for that day with the approval of the Chinese State Council. Under the new currency regime, the starting rate would have to be closer to the previous day’s closing rate, greater emphasis would be put on supply and demand conditions in the foreign exchange market, and there would be limited intervention (Pettis, 2015).This is a small step toward the liberalization of the renminbi, but an important one.
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69 At the end of November of 2015 China did succeed in its goal of receiving Special
Drawing Rights and being counted among the elite list of currencies including the dollar (41.73 percent), the euro (30.93 percent), the renminbi (10.92 percent), the yen (8.33 percent), and the pound (8.09 percent) (IMF, 2015a). Certainly, a hard fought win for the Chinese government;
however, was it an exercise of economic coercion? Their ability to express autonomy in their monetary policy and their seeming success in shaping United States policy when they backed the renminbi’s ascension to Special Drawing Rights status would suggest so. As we saw above, however, it is clear that their monetary policy was constantly being thrown into question by market forces and they are still on unequal footing as the renminbi continues to depreciate, and capital continues to flow out. This is partially because the dollar is rising quickly in value and through the Chinese government’s own choices the renminbi no longer enjoys its tie to the dollar.
In terms of Chinese using the influence their reserves gain them to achieve United States backing for their ascension to Special Drawing Rights, it is hard to say that the United States was swayed by the Chinese debt holdings and their steading move, not just away from buying
treasuries, but also into selling them. Instead, it is more likely that the United States saw greater opportunity in the IMF force China to adhere to the rules of free capital flow and market oriented currency evaluation that are required for reserve currency status. Indeed, the United States ultimately backed China’s bid to have the renminbi recognized as a global reserve currency.
This followed further financial reforms such as allowing foreign central banks and sovereign wealth funds greater access into China (Mayeda, 2015). Such an exchange doesn’t represent the overwhelming exercise of coercion, but at best a convergence of interests between the two parties. The United States benefits from another cooperative power that upholds the economic
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70 system and world order that has provided relative peace since World War II, and China holding more responsibility in the IMF can help bring that reality into fruition.
Furthermore, it is of note that the United States only lost .17 in their holdings. The Euro suffered the greatest loss at a little over 6 percent, with the pound and the yen losing 3.21 and 1.07 respectfully. Even as China hoped to move away from their reliance on the dollar, bolstering their ability to hold more of their domestic currency with near the same risk and reward as the dollar, they did little to weaken the dollar’s international position. This does not fit with the image of systematic disruption trying to weaken a dollar dominated global economy or an attempt to destabilize the dollar’s valuation as Kirshner would be necessary to fit the
traditional Kirshner definition of monetary power (Kirshner, 1995, p. 3).
China did show signs of autonomy in monetary policy, which Cohen recognizes as a passive form of economic power in which a country cannot be dictated to (B. j. Cohen, 2008).
Even so, it came at a high cost and showed the difficulties of utilizing even the most efficient – as Kirshner posits it to be – tools of economic coercion. Instead, in the three categories Kirshner provides to measure for an economic coercive tools ability to succeed – feedback, defense or circumvention, and efficiency (Kirshner, 1995)– China’s exercise of monetary power to achieve SDR status it ranks low on all three.
China suffered large feedback costs due to their changes in monetary policy. The biggest example of which was the quick response from businesses and wealthy citizens in exchanging their renminbi for other foreign currency assets, and moving other assets overseas. This created an even greater strain on an already artificially high renminbi, and sparked the slow bleed from
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71 the State Administration for Foreign Exchange’s foreign reserve holdings, which as noted above, fell $512.7 billion in 2015 and continues to fall.
In terms of United States defensive or Circumvention, it is hard to say that any
extraordinary steps needed to be taken. As China began to sell U.S. treasury bonds there was no collapse in the demand as some assumed. Instead, demand was met in some areas of the world as well as growth in the American economy filled in the shortfall. Market forces helped the United States circumvent negative effects of China’s sell-off of U.S. treasuries so that the government itself didn’t have to act (Chovanec, 2015). Furthermore, as far as retaliation it seemed that China was doing its best to defend against the negative consequences of currency regime change, and no immediate action from the United States was necessary.
Lastly, China’s exercise in monetary power could hardly be considered efficient. They did achieve their goal of uncoupling from the U.S. dollar, gaining greater autonomy in their ability to hold more renminbi with all of the same perks of holding another IMF reserve currency, and stave off economic instability at home. As argued earlier, these were the most important goals of the Chinese government and all were achieved. Although economic crisis is always, constantly looming, China didn’t go away empty handed for their efforts; however, there were great concessions that were made, in finance liberalization and currency regime change, that shouldn’t be necessary if China’s real-term monetary power matched the theoretical model.
Furthermore, although it probably wasn’t their main objective, their actions failed to be significantly reduce United States influence. For this reason, the measures taken can’t be considered very efficient.
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