China's Currency: The Yuan or Renmimbi

Does China Manipulate Its Currency?

China wants the yuan to become the world's dominant currency. Lucas Schifres / Getty Images

Definition: The yuan is China's national currency. It's known locally as the renminbi (RMB), which means "the money of the people." The renminbi is the official name for the currency, and the yuan is a unit of the currency. It is pronounced yoo-ahn.

The yuan has a critical role in keeping China's economy competitive. China has historically pegged the yuan to a basket of currencies filled mostly with the U.S. dollar.

That means it kept the yuan's value in a 2% trading band around a "reference rate" that tracked the dollar's value. That was around 6.25 yuan to the dollar. In other words, one dollar could be exchanged for 6.25 Chinese yuan.

On August 11, 2015, China modified its policy to allow the yuan greater market volatility. It announced the "reference rate"  would be equal to the previous evening's closing value on the foreign exchange markets. The dollar to yuan value immediately fell 1.9%. The next day the yuan dropped even further, to roughly 6.3845. At that point, China intervened to control the rapid descent, keeping the yuan in a holding pattern at around 6.389 yuan to the dollar. By August 24, it had weakened to 6.4064 yuan per dollar. (Source: "China Intervenes to Support Tumbling Yuan," The Wall Street Journal, August 12, 2015.)

Since then the yuan has continued to fall. On January 11, 2016, the yuan was 6.58055.

That volatility panicked investors, sending the Dow down more than 1,000 points the first week of the year.  The government guided the yuan lower throughout the year. On October 1, 2016, it reached a six-year low of 6.7008.  (Source: "China Fixes Yuan at Six Year Low," The Wall Street Journal, October 9, 2016.)

How Does China Manage the Yuan's Value?

Exactly how does China maintain the yuan's value? The People's Bank of China (PBoC) is the country's central bank. It promises to redeem dollars for yuan at the current exchange rate. To do so, it must keep a good supply of dollars in its foreign exchange reserve. Instead of holding dollar bills, it holds U.S. Treasuries, which it can quickly sell for dollars. As China's economy grows, it must buy more and more U.S. Treasuries to meet the growing number of yuan being redeemed by its exporters. As a result, China is one of the largest foreign holders of Treasuries.

To stop the yuan from falling further, the PBoC bought massive quantities of yuan, reducing the money supply. This contractionary monetary policy slows economic growth by raising interest rates. To counteract this, the PBoC has been doing its own form of Quantitative Easing, adding 150 billion yuan ($23.44 billion) to banks' balance sheet. (Source: "The Daily Shot," August 21, 2015.)

Is China Guilty of Currency Manipulation?

Why is China changing its policy? On November 30, 2015, the International Monetary Fund (IMF) added the yuan to the world's official foreign exchange reserve currencies.

That also includes the U.S. dollar, the euro, the yen and the British pound. That's the first step for the yuan to replace the dollar as the global currency. (Source: "The Yuan and the SDR," The Economist, August 5, 2015.)

In 2013, China allowed British investors to invest $13.1 billion, or 80 billion yuan, in its capital markets. That made London a major trading hub for the yuan, the first outside of Asia. China has also allowed forex trading in Shanghai. These steps mean the yuan is the 11th most traded, the 8th most used for foreign transactions, and the 7th among currencies in countries’ official reserve assets. (Source: "U.K., China to Increase Yuan's Role," The Wall Street Journal, October 16, 2013.)

To truly let the yuan freely float, China should allow all its residents to hold foreign currency and buy foreign assets.

This would allow the Chinese Government to hold fewer dollars and lessen the trade imbalance with the U.S. 

In February 2015, China held nearly $1.2 trillion in U.S. debt. China often calls for a new global currency, including the yuan, to replace the dollar. China gets concerned when the United States threatens to default on its debt like it did in 2011 and 2013. China also worries when the dollar's value declines. China rattles its sabers like this whenever it sees its holdings of dollars lose value.

Between 20015 and 2014, China allowed the yuan to rise against the dollar. It responded to U.S. allegations of a currency war. It also wanted to keep its 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 PBoC allowed the yuan to weaken again to boost exports. This will strengthen China's economic growth, which is slowing too much thanks to reforms. (Source: "With Yuan Move, China Take U-Turn," The Wall Street Journal, August 11, 2015.)

China is the world's largest economy. It produced $19.5 trillion in 2015, more than the European Union or the United States. But its standard of living, as measured by GDP per capita, is only $14,300. That is worse than some smaller countries, such as Iraq or Romania. Chinese leaders want prosperity to rise so the people are happy. China also needs to build its domestic market power so it isn't so reliant on exports to the United States. (Source: CIA World Factbook, 2015 estimates.)

If China is guilty of currency manipulation, then so are many other countries. The United States was keeping the dollar low by keeping interest rates at zero and having the world's largest debt. That changed in 2014 when the dollar entered an asset bubble. Japan keeps its currency low by doing the same as China and buying dollars in the form of U.S. Treasuries. Even the European Union has finally started lowering the euro by adopting its own form of Quantitative Easing. In other words, all exporting nations benefit from a lower currency. 

China's Yuan Policy Keeps the Dollar Strong

Right now, the dollar is used as the currency of choice for most international contracts. All oil contracts must be transacted in dollars. This has been the case since the Nixon Administration took the dollar off the gold standard in 1973.

The dollar being the world's global currency is one reason the U.S. debt has grown so large. It keeps the dollar in demand, thus keeping Treasury interest rates low. China's desire to keep the yuan low makes it buy U.S. Treasuries. This keeps yields low, which helps the U.S. housing market by keeping fixed mortgage rates low. For more on how this works, see The Relationship Between Treasury Notes and Mortgage Interest Rates.

China could, theoretically, threaten to sell its Treasury holdings, putting the value of the U.S. dollar into freefall. However, it's not in China's best interests to do so. By threatening to sell U.S. Treasuries, 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.