« China now has to watch not only trade but also capital outflows… »
Seven was the line in the sand.
But the Chinese yuan never crossed that line vis-à-vis the U. S. dollar. It only crept up to 6.96 yuan per dollar on Dec. 16,2016, before starting an impressive comeback, down to 6.5 in the middle of this year.
Last year was a bad one for the Chinese economy. Growth was slow, and the world was worried China would finally land the hard way, as many have been predicting for years.
And more than GDP growth or any other metric, the Chinese currency was the barometer of whether China could keep things stable – stability is the mantra of the ruling communist regime – or suffer a crisis of debt deflation.
If it declined in value, it meant citizens and companies were moving money out of the country in droves because they didn’t believe in the Chinese dream anymore.
So another measure of how bad things had gotten in the second-largest economy of the world was capital outflows.
According to the Institute of International Finance (IIF), a record $725 billion left China in 2016, putting pressure on the currency and the Chinese interbank market.
Trying to stem the tide, the central bank sold record amounts of foreign currency. Chinese foreign exchange reserves, $4 trillion at the peak in 2014, went down to $3 trillion, and analysts started to question whether this was enough to finance the world’s largest trading economy.
Then, miraculously in time for the 2017 National Congress of the Communist Party, all of this stopped. The yuan never went above 7, the exchange reserves never went below 3, and capital outflows subsided thanks to draconian regulations making it harder for individuals and companies to move money out of the country.
But something else helped China to strengthen its currency to reduce capital outflows and to balance foreign exchange reserves: a weak dollar.
The dollar didn’t only decline against the yuan. It declined against virtually all of its major trading partners in 2017, dropping 12 percent from its Jan. 2 peak to its Sept. 4 trough.
A weak dollar takes pressure off the yuan and makes it less desirable for Chinese to invest in U. S. assets if they stand to lose money on the currency. A weak dollar makes Chinese foreign currency holdings in other currencies worth more.
But the weak dollar is bound to reverse in 2018, and for China, this means going back to the uncertainty of 2016.
Currencies move for a myriad of reasons, but this year’s drop in the dollar had three major pillars.
