China\\\'s Economic Challenges: Preventing a Vicious Cycle with the Yuan

Explore the economic challenges faced by China, including the sacrifice of the Yuan to prevent a vicious cycle of low demand and declining output. Learn why experts believe immediate action is crucial.

China's Economy in Crisis

China is currently facing a series of economic difficulties, with negative consumer prices and deflation plaguing the nation.

China's Economic Challenges: Preventing a Vicious Cycle with the Yuan

The burden of excessive spending and Covid-19-related monetary policies has left both the public and private sectors drowning in debt. These challenges have the potential to create a vicious cycle, where low demand leads to low output, resulting in low income and causing an even further decline in demand. To prevent this from happening, experts suggest that immediate action is needed.

Economic Stimulation Measures and the Role of the People's Bank of China

To combat the economic crisis, the People's Bank of China (PBOC) must take additional measures alongside existing efforts to stimulate the economy. Quantitative easing, a strategy similar to the bond purchases initiated by the US Federal Reserve Bank and other monetary authorities during the 2008 global financial crisis, could be a viable option. However, such a move poses a major concern for China's leadership - it could weaken the Yuan.

The Yuan's Depreciation and Foreign Investors' Concerns

Over the past year, the Yuan has experienced a depreciation of about 5% against the US dollar. Additionally, foreign investors have been rapidly selling off Chinese stocks. This is a worrying trend for the Beijing government, as a continued depreciation of the Yuan may exacerbate the stock sell-off. However, economic experts believe that if rescuing the economy from deflation requires a weaker Yuan, it may be a price worth paying. In fact, it could even serve as an effective mechanism to boost foreign demand for Chinese products.

Pressure on the Yuan: Yield Gap and Its Impact

China's Yuan is currently under significant pressure, particularly due to the growing yield gap between the country and other major economies, especially the US. On September 8, the Yuan plummeted to its lowest level since the 2008 global financial crisis, reaching 7.3415/USD at the end of the domestic trading session. Moreover, in overseas trading, it fell to a record low of 7.3623/USD, surpassing the critical threshold of 7.35 Yuan/USD.

Maintaining Stability and the "Impossible Trinity"

The PBOC faces a daunting task of maintaining stability by exercising control over the exchange rate and preventing capital outflows while simultaneously managing monetary policy. This challenge, often referred to as the "impossible trinity," is not new for Beijing, as it has had to confront similar issues in the past, such as during the 2015 devaluation of the Yuan and amidst the trade war with the US five years ago. In such circumstances, policymakers tend to prioritize economic growth and may allow controlled price cuts, as a weaker Yuan strengthens Chinese exports.

The Future of the Yuan and its Uncertain Path

The trajectory of the Yuan largely depends on the overall development of the US dollar, a factor that is difficult to predict accurately. Recent events, however, seem to support the forecast of a year-end exchange rate of 7.6 CNY/USD.

Navigating through Economic Challenges

To prevent a vicious cycle from plunging China's economy into further distress, it is crucial for the government to take necessary measures. While sacrificing the Yuan may be an unintended consequence, policymakers are willing to accept the potential impact on the exchange rate if it stabilizes the economy. The future remains uncertain, and the path of the Yuan will ultimately be shaped by the economic dynamics unfolding on a global scale.