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China’s Currency Control: How it Works

The Chinese yuan fell to its lowest level in over a year, dropping 9% since April, as the ongoing trade war between the U.S. and China continues to affect global markets.


U.S. President Donald Trump, a staunch opponent of China’s use of currency manipulation to bolster its enormous export industry, said in July that the yuan is “dropping like a rock”.


Artificial Pricing

Unlike other major currencies (EUR, USD, GBP etc.), the yuan is not traded freely with buyers and sellers determining its market price. Instead the People’s Bank of China (PBOC) sets a range in which the yuan is permitted to move – typically no more than 2% in either direction.


AXA Investment Managers’ Aidan Yao also believes Beijing’s insistence on keeping a firm grip on the currency is based on protecting its export market, stating, “When China was first opening up its economy in the 1970s and 1980s, it was in the country’s interest to keep the yuan artificially low to make its growing export industry more competitive against Asian rivals”.


The Chinese Central Bank

Just like the Fed in the U.S., The PBOC sets interest rates and uses other monetary policy tools to control the value of the nation’s currency.


However, unlike the Federal Reserve, the PBOC does not have independent control over monetary policy mechanisms. Instead, it takes its orders directly from the leaders of China’s ruling Communist Party.


In addition, the PBOC, again uncommonly for a major central bank, is also a very active market participant, using state-owned financial institutions and China’s huge foreign currency holdings to manipulate the price of the yuan.


“The PBOC is still a major player in the foreign exchange market. You don’t really see that same kind of intervention with the Fed, European Central Bank or the Bank of Japan”, said Yao.


The Last Four Months

Even though Beijing has a strong track record of keeping the yuan down, many analysts are unconvinced that the recent slump is intentional, citing the U.S. / China trade war and a cooling Chinese economy as driving factors.


While it is true that yuan weakness does lessen the effect of U.S. trade tariffs by lowering the cost of exports, experts believe that Beijing would prefer to stabilise the currency right now, citing recent moves that make betting against the yuan significantly more expensive.


What Happens Next?

The Chinese leadership understands that, in the longer-term, it must allow the markets to determine the trading level of the yuan. However, progress toward this end has been extremely slow.


In the last ten years, a market has developed outside of China for currency investors to trade a version of the yuan relatively freely, albeit firmly linked to the “China price”.


This article is for educational and informative purposes only and should not be considered as investment or trading advice.