China’s Currency Conundrum: Navigating the U.S. Tariff Storm|| Digging into China

Hi, I'm Dong Xiong. Welcome to Digging into China, where we explore China in-depth to review unique perspectives. Since May of this year, both onshore and offshore Chinese yuan have strengthened against the US dollar, rising from an exchange rate of 7.4 to 1 to the current 7.12. In just three months, the yuan has appreciated by 3.8%. In China, this strengthening has been widely celebrated by economic analysts, who view it as a sign of the nation's growing global influence and a triumph in the US-China trade conflict. Chinese media outlets are abuzz with speculation about when the yuan might break the 7 to 1 threshold against the dollar. However, from a global perspective, the US dollar index has declined from a peak of 108 points last December to approximately 97.8 today, a drop of about 9%. This means the dollar has, on average, weakened by 9% against major currencies such as the euro, yen, pound, and Canadian dollar, but only by 3.8% against the yuan. If we regard the yuan as a freely floating currency within the international monetary system, its 3.8% appreciation against the dollar suggests it is actually depreciating against the other major global currencies. So what is there to celebrate? Historically, China's strategy of pegging the yuan to the dollar would have led to the yuan depreciating alongside the dollar. Yet, this time, the yuan has defied expectations, appreciating by 3.8% while the dollar weakens. This means the yuan is neither rising nor falling in tandem with the dollar's depreciation. Instead, it is gaining value against the dollar while losing value against other major global currencies. Why has the yuan diverged from its previous dollar-pegging policy to appreciate against the dollar? Let's explore the international economic dynamics driving this shift. In late August, Federal Reserve Chairman Jerome Powell's public remarks solidified market expectations of interest rate cuts. Such cuts increase dollar liquidity in the market. Traditionally, more dollar liquidity translates to greater global liquidity. But this assumes a globally integrated economy with unrestricted capital flows, a reality that no longer holds. The conservative policies of the Trump administration have employed tariff wars to erect regional barriers to global trade. As these tariff battles conclude, the era of integrated global trade has given way to regionalized trade barriers. The United States, the world's largest consumer market, is shifting its supply chains back to home, prioritizing domestic production. Consequently, a significant portion of the additional dollars generated by Fed rate cuts no longer flows abroad through international trade. Recently, President Trump convened an investment summit with major Silicon Valley firms, where nearly all U.S. companies pledged to increase domestic investments. For instance, Meta and Apple each committed $600 billion, Google pledged $250 billion, and even Microsoft, often at odds with Trump, promised $80 billion. These major corporations are channeling funds into the U.S. As a result, not only do the additional dollars from Fed rate cuts remain in the U.S., but these global firms are also repatriating profits earned abroad for domestic investments. Over the next 2-3 years, even if the Fed continues to cut rates and increase dollar circulation, most of these dollars will stay within the U.S., with little flowing abroad through trade or investment. The rise of American conservatism means Fed rate cuts now primarily boost U.S. economic liquidity, not global liquidity. This shift poses a critical challenge for China, which relies heavily on exports to the U.S. to drive growth and accumulate dollar reserves. How will China navigate this changing global trade landscape? Official Chinese data shows that in August, China's exports to the U.S. fell by 33% year over year, reducing the dollars earned through trade by one-third. As Trump's trade balancing policies persist, the dollar liquidity the U.S. provides to the world through imports will continue to shrink. This will fundamentally alter the dollar's role as the primary currency for international trade settlements and payments, as well as the main reserve asset for central banks worldwide. Currently, the dollar accounts for over 40% of international trade settlements and payments, a share sustained by U.S. trade deficits that provide global dollar liquidity. If the U.S. achieves balanced or near-balanced trade, global dollar circulation will inevitably decline, making it impossible to maintain the dollar's dominance in over 40% of trade settlements. Without sufficient dollars for payments, international trade among non-U.S. countries will face disruptions. To secure enough dollars for imports, countries must establish trade, investment, or currency swap agreements with the U.S. Otherwise, dollar shortages will create trade barriers, particularly impacting export-driven economies like China, which faces domestic resource constraints and relies on exports for growth. If China cannot earn enough dollars through exports, it will struggle to import the resources needed for economic development, risking economic decline or collapse. This explains China's proactive approach in recent U.S.-China tariff negotiations. For example, Vice Minister of Commerce Li Chenggang traveled to the U.S. for talks on China's initiative not at the U.S. government's invitation, demonstrating China's sincerity. While progress has been limited, China maintains a cooperative stance. A breakdown in relations with the U.S. could sever China's access to dollars, potentially collapsing its economy within three years. Some nationalist voices in China argue that the U.S. is forced to negotiate because it depends on China's rare earths. In reality, China faces the highest global tariffs imposed by the U.S., exceeding 55%, surpassing even India's punitive 50% tariffs. Meanwhile, China's official August trade data shows a 22% year-on-year increase in rare earth exports. This suggests that, despite tough rhetoric, China is complying by boosting rare earth exports under pressure. For the U.S., the success or timing of trade talks with China is not urgent. Even if talks fail, the current situation where the U.S. imposes an average tariff of more than 57% on Chinese goods while China's tariffs on U.S. goods average 32% represents a victory for Trump's tariff strategy. China's exports to the U.S. dropped by one-third in August, pulling overall export growth down from 7.2% in July to 4.4% in August. This decline slows GDP growth, but more critically, it significantly reduces the dollars China earns through trade. Additionally, foreign capital is rapidly exiting China, further straining its foreign exchange reserves. Official Chinese data reveals that over the past year, despite large monthly trade surpluses, foreign exchange reserve growth has been far smaller than expected. For instance, August's trade surplus was $102 billion, but reserves grew by only $30 billion. This indicates that much of the trade surplus isn't translating into reserves. Partly because some export firms aren't repatriating earnings, and more significantly, because the capital outflows are accelerating. If U.S.-China trade talks collapse and the U.S. restricts dollar access, the consequences for China's economy would be catastrophic. To sustain normal trade, China must compromise with the U.S. to secure adequate dollar reserves. This compromise is evident in increased rare earth exports, proactive negotiation efforts by the Vice Minister of Commerce, and China's reduction of tariffs on U.S. goods to 32% compared to the U.S.'s 57% on Chinese goods. While making concessions to the U.S., China is also working to build its own trade bloc, such as proposing a Shanghai Cooperation Organization bank and strengthening ties with non-U.S. countries through SCO and BRICS summits to create a China-centered trade network. However, trade requires both demand and supply. In the previous globalized trade system, demand came almost entirely from the West, while supply came from developing nations. Without Western demand, international trade lacks its primary driver, akin to an industry association where all members produce similar goods, unable to form an economic community. China recognizes this. So while pursuing a new trade bloc, it continues to compromise in U.S. trade talks to stabilize its economy. The Yuan's 3.8% appreciation over three months is another such compromise. Yuan appreciation benefits the U.S. more than raising tariffs on Chinese goods. Unlike tariffs, which could raise import costs for U.S. firms, appreciation adds no circulation cost. It achieves the same effect as a tariff increase without the potential downsides for the U.S., making it an effective tool to reduce China's trade surplus. For China, facing high U.S. tariffs and significant capital outflows, Yuan appreciation makes exporting to the U.S. more challenging. A 3.8% appreciation against the dollar effectively raises the cost of all Chinese exports to the U.S. by over 3.8%. It also enables foreign firms exiting China to exchange their Yuan for more dollars. In both trade and capital terms, this appreciation is detrimental, a concept clear to anyone with basic reasoning. Thus, the Yuan's appreciation, like increased rare earth exports and reduced tariffs, is a significant concession in U.S. trade negotiations. While making these concessions, China has quietly manipulated the Yuan's exchange rate against major non-dollar currencies to offset trade losses from dollar appreciation. Data from the China Foreign Exchange Trade System, managed by the People's Bank of China, shows the Yuan exchange rate index fell to 95.49 on June 13. The Yuan has depreciated nearly 10% against the euro since late 2024, hitting 8.44 in late April, an 11-year low. Since last November, it has weakened by 12.7% against the euro. The eurozone is China's second-largest export market, and it appears the government aims to offset losses from U.S. concessions by depreciating the Yuan against euro to boost EU exports. Similarly, the Yuan has depreciated significantly against ASEAN currencies, such as a 10% drop against the Thai baht, indicating aggressive Chinese goods dumping in ASEAN markets. The Yuan's 3.8% appreciation against the dollar, paired with significant depreciation against the other major trading partners' currencies, reflects China's substantial concessions in the U.S. tariff war, while striving to maintain global goods dumping. Behind this structural shift lies China's profound fear of losing its dollar reserves. Thank you so much for watching. If you find this video helpful, please like it, drop a comment below, and hit the subscribe button right here. It really helps YouTube suggest my videos to others. I'll be back with more content soon. Until then, be well.