China's Currency, the Yuan or Renminbi
Does China Manipulate Its Currency?
China’s currency is often referred to as yuan or renminbi, but the two terms aren’t exactly interchangeable. Renminbi means “People’s currency” and is used to describe Chinese currency in general, while the yuan is a unit of measure that can be counted. Therefore, one can talk about the state of the renminbi as a currency and/or any number of yuan being transacted. A good way to think of the difference is "cash" versus "dollars" in the United States.
The renminbi is also referred to as RMB, as U.S. dollars are known as USD.
China pegs its currency to the U.S. dollar, as the dollar is used for most international trade transactions and has been the world's reserve currency since the 1944 Bretton Woods Agreement. And because America is China’s biggest trading partner, China manages its currency to keeps its export prices reasonable compared to U.S. competitors. Every country would like to do this, but China's command economy allows the Communist Party to control the central bank and critical businesses.
China’s use of the yuan for its competitive strategy has worked. In 2014, China became the world's largest economy. In 2018, it produced $25.3 trillion in gross domestic product (GDP). China's GDP is more than what the European Union or the United States produces.
But China must keep growing. Its standard of living is only $18,120 as measured by GDP per capita. Chinese leaders want prosperity to rise so that people will buy more, allowing Chinese businesses to sell at home instead of exporting to the United States.
How China Manages the Yuan's Value
A country’s currency can influence its economic dynamics. Lower currency valuations make exports cheaper, since goods are priced in the country’s local currency, while higher currency valuations make imports less expensive, since the local currency is then relatively more valuable than the export country’s currency.
The People's Bank of China manually adjusts the yuan's value to track that of the dollar. China's exporters receive dollars when they ship goods to the United States. They deposit them into their local banks, which transfer it to the central bank, in exchange for yuan, used to pay their workers and local suppliers.
China’s movements also influence the value of the U.S. dollar. China’s central bank will use its dollar reserves to buy yuan from Chinese banks. By taking yuan out of circulation, the bank increases the yuan's value. By replacing yuan with dollars, it puts more dollars into circulation and lowers the yuan’s value.
A rapidly growing country facing the prospects of a rising currency valuation can effectively peg their currency to one with a lower valuation. In the case of the U.S. and China, this involves China purchasing U.S. Treasuries to keep the yuan exchange rate at a certain ratio with the dollar. These strategies have resulted in China's significant holding of U.S. Treasury bonds.
China has become one of the largest foreign holders of U.S. Treasuries. In theory, China could threaten to sell its U.S. Treasury holdings and put the value of the U.S. dollar into freefall, but it's not in China's best interests to do so. By threatening to sell U.S. Treasurys, China would quickly devalue its own holdings. Even so, it's been unwise for the United States to allow itself to become so indebted to any other country.
China: Guilty of Currency Manipulation?
China has faced many allegations of currency manipulation, particularly from the United States, when it pegged its currency to the U.S. dollar. While the country lifted its peg to the U.S. dollar in 2005, it was reinstated during the 2008 economic crisis.
If China is guilty of currency manipulation, then so are many other countries. The U.S. kept the dollar low by maintaining interest rates at zero and accumulating the world's largest debt until 2014 (when the dollar entered an asset bubble). Japan keeps its currency low by buying dollars in the form of U.S. Treasuries. The European Union has lowered the euro by adopting its own form of quantitative easing. In other words, all exporting nations benefit from a weaker currency.
Between 2011 and 2014, China allowed the yuan to rise against the dollar despite U.S. pressure—China wanted to keep the Chinese economy from overheating and creating inflation. As a result, on January 26, 2014, the dollar to yuan rate reached an 18-year high of 6.0487 yuan.
Since then, the People’s Bank of China has allowed the yuan to weaken again in order to boost exports and strengthen China's economic growth, which had become sluggish. This move was welcomed by developed countries hoping that the country would move towards a free-floating valuation.
On August 8, 2019, China's central bank lowered the yuan to 7.0039 per dollar. That's the weakest since April 21, 2008. China has been lowering the yuan to offset tariffs imposed by President Trump's trade war.
The U.S. responded by designating China a “currency manipulator.”
China’s Yuan: The Next Global Currency?
China gets concerned when the United States threatens to default on its debt as it did in 2011 and 2013. China also worries when the dollar's value declines, and has called for a new global currency whenever it sees its holdings of dollars lose value. China wants the yuan to replace the dollar as the global currency.
China’s first step occurred in 2013. China allowed British investors to invest $13.1 billion or 80 billion yuan in its capital markets, which made London the first major trading hub for the yuan outside of Asia. China also allowed forex trading in Shanghai. As a result, the yuan became the 11th-most traded, the eighth-most used for foreign transactions, and the seventh among currencies in countries’ official reserve assets.
The next step occurred on November 30, 2015. The International Monetary Fund allowed the yuan to become an official foreign exchange reserve currency. It also required China to loosen its peg.
To truly let the yuan float, China must allow all its residents to hold foreign currency and buy foreign assets. The Chinese government would hold fewer dollars and lessen the trade imbalance with the United States.
How to Invest in Chinese Currency
ETFs are the easiest way to gain exposure to Chinese currency. If the Chinese currency appreciates during the holding period versus the U.S. securities, the position generates a profit that is then reflected in the ETF’s price.
Using the foreign exchange (or forex) market, investors can simultaneously buy Chinese currency and sell another currency to realize a profit from the difference. But in this case, investors must use leverage as high as 400:1 in order to realize gains which makes it a riskier venture.
The Balance does not provide tax, investment, or financial services and advice. The information is being presented without consideration of the investment objectives, risk tolerance, or financial circumstances of any specific investor and might not be suitable for all investors. Past performance is not indicative of future results. Investing involves risk including the possible loss of principal.
Brookings Institution. "What’s the Difference Between the Renminbi and the Yuan? The Answer to This and Other Questions in “Renminbi Internationalization.'" Accessed April 29, 2020.
U.S. Department of Treasury. "Treasury Designates China as a Currency Manipulator." Accessed April 29, 2020.