China’s currency, the renminbi or yuan, is tied to the U.S. dollar, the currency of China’s largest trading partner. China does this to hedge against risks in changes to the dollar’s value. China also has been accused of deliberately keeping the yuan’s value low to depress its export prices, but currency manipulation is difficult to prove.
What Is the Yuan or Renminbi?
China’s currency is called the yuan or renminbi. The terms have slightly different usages. Renminbi means “People’s currency” and describes Chinese currency in general. A yuan is a unit of measure. A good way to think of the difference is “cash” versus ”dollars.
How the Yuan and Dollar Affect Each Other
China pegs its currency to the U.S. dollar, its largest trade partner. China is not unusual in doing this. Most countries tie their currency to either the U.S. dollar or the currency of their largest trading partner. It keeps the local currency’s value stable, helping businesses and investors to trade with confidence.
The People’s Bank of China (PBOC) manages the yuan’s value so that it rises and falls along with the dollar. The dollar’s value fluctuates because it’s on a floating exchange rate. China switched from a strictly fixed exchange rate in July 2005. So its currency is now more flexible but is still managed with a close eye.
How China Accumulates Dollars
China’s exporters receive dollars when they ship goods to the U.S. They deposit them into their local banks. The bank pays them renminbi in return, which they use to pay their workers and local suppliers.
The local banks then transfer dollars to the central bank. It uses the dollars to purchase U.S. Treasury bonds, which pay interest. As a result, China has become one of the largest foreign holders of U.S. Treasurys.
How China’s Central Bank Manages the Yuan
The PBOC monitors the yuan’s value relative to the dollar. If the dollar rises too far above the peg, the bank will sell Treasurys on the secondary market.
By adding to the supply of Treasurys for sale in the market, their value drops, along with the value of the dollar. It also gives the PBOC cash to purchase more yuan, raising the currency’s value.
Why Is China Accused of Currency Manipulation?
Any country that keeps its currency artificially low to boost cheap exports can be accused of currency manipulation. Countries with low currency values export more because their products cost less than their competitors’ products.
Currency manipulation is difficult to prove. A fixed exchange rate, by its very nature, exposes a country to accusations of currency manipulation. To make its case, the accusing country must prove that the accused kept its currency low simply to increase exports. In August 2019, the U.S. designated China as a “currency manipulator.” According to the U.S. Treasury Department, China has a history of undervaluing its currency to gain an unfair competitive advantage.
Since 2014, when the yuan reached an 18-year high, China has been lowering the value of its currency.2 There are many reasons for that. In 2014, the dollar rose 15% against most major currencies, dragging the yuan up with it. As a result, the yuan was overvalued compared with other trading partners not pegged to the dollar.
In 2015, the International Monetary Fund (IMF) designated the yuan as an official reserve currency. The IMF required the yuan to be more driven by market forces. As China relaxed controls, the yuan experienced greater market volatility. But the yuan didn’t rise, as many thought it would. It fell, indicating that the market thought the yuan was overvalued.
In 2019, China lowered the yuan’s value. It might have been trying to offset the rising cost of tariffs imposed by President Trump’s trade war. Later that year, the U.S. made its declaration about China being a currency manipulator.
How Does the Yuan Affect You?
When the yuan’s value is low, it reduces the prices of many products imported in the U.S. and other countries from China, which can be seen as positive by consumers. The biggest categories are computers, cell phones, apparel, and toys/sporting goods. Low import prices also minimize the threat of inflation.
But a low yuan value is one reason for the large U.S./China trade deficit. The other reason is that China can pay its workers less than U.S. companies can because China’s cost of living is lower.
China’s demand for Treasurys helps keep U.S. interest rates low. That boosts the U.S. economy by lowering the cost of loans and allowing Congress to increase federal spending.
China’s peg also influences the value of the U.S. dollar. When China’s central bank sells Treasurys, it lowers the dollar’s value by increasing the supply of dollar-denominated assets.
A dollar collapse won’t likely happen, however, because it’s not in China’s best interests. Selling a big chunk of Treasurys would quickly devalue China’s own remaining holdings. Even so, it’s unwise for the U.S. to allow itself to become so indebted to any other country.
How Can I Invest in Chinese Currency?
Investing in Chinese currency is unnecessary because it is still loosely tied to the dollar. If the yuan rises, it’s only because the dollar has, too. There is an additional risk added in by the Chinese government. It could modify the value of the yuan for political reasons. This is difficult to anticipate and, therefore, profit from.