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Trump’s Imaginary Enemy

Summary:
SHANGHAI – Last month, China commemorated the 20th anniversary of the death of Deng Xiaoping, the chief architect of the economic reform and opening up that catapulted the country to the top rungs of the global economic ladder. The anniversary comes at a time when economic openness is under threat, as the United States is now being led by a president who believes that the way to “make America great again” is to close it off from the world. In particular, Donald Trump’s administration is posturing for a stricter approach to China, which he claims has been “raping” the US with its trade policies, including by keeping the renminbi’s value artificially low. Whatever concrete steps Trump takes, it seems clear that US policy will be economically tougher on China in the coming years, potentially even triggering a trade war. But, as a closer look at China’s financial policy stance shows, China is not America’s foe. Just a few months ago, China was confronted with the urgent challenge of preventing the continued depreciation of the renminbi and cooling down an overheating real-estate market. This would be no easy feat, not least because the authorities’ efforts to stem the renminbi’s decline were rapidly shrinking China’s foreign-exchange reserves.

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SHANGHAI – Last month, China commemorated the 20th anniversary of the death of Deng Xiaoping, the chief architect of the economic reform and opening up that catapulted the country to the top rungs of the global economic ladder. The anniversary comes at a time when economic openness is under threat, as the United States is now being led by a president who believes that the way to “make America great again” is to close it off from the world.

In particular, Donald Trump’s administration is posturing for a stricter approach to China, which he claims has been “raping” the US with its trade policies, including by keeping the renminbi’s value artificially low. Whatever concrete steps Trump takes, it seems clear that US policy will be economically tougher on China in the coming years, potentially even triggering a trade war. But, as a closer look at China’s financial policy stance shows, China is not America’s foe.

Just a few months ago, China was confronted with the urgent challenge of preventing the continued depreciation of the renminbi and cooling down an overheating real-estate market. This would be no easy feat, not least because the authorities’ efforts to stem the renminbi’s decline were rapidly shrinking China’s foreign-exchange reserves.

The situation was so grim that some international investors and economists suggested that the government would have to give up on managing housing prices and focus, instead, on propping up the exchange rate, as Japan, Russia, and South Asian economies had done. China, they argued, could not allow its hard-earned foreign-exchange reserves to slip away.

But, after partly decoupling the renminbi from the dollar in August 2015, the People’s Bank of China (PBOC) tried hard not to intervene to boost the renminbi’s value. As China’s economic growth continued to decline and America’s continued to recover, the renminbi’s exchange rate continued to fall.

Some observers might have wondered whether the PBOC purposely allowed the depreciation to boost China’s trade competitiveness in advance of a potential victory by Trump in the US election – a result that many assumed would weaken the US dollar. Perhaps it did. But it did not actively devalue the renminbi.

When Trump’s election as US president defied expectations and made the already-strong dollar rise further, depreciation pressure on the renminbi intensified. By the end of last year, the renminbi had depreciated by around 15% against the dollar from the summer of 2015, and rapidly rising expectations of further depreciation were driving more investors to take their capital out of China.

The PBOC had to take stronger action to contain the renminbi’s decline. To stabilize exchange-rate expectations, it imposed tighter restrictions on short-term capital outflows. At the same time, it took its previous efforts to decouple the renminbi from the dollar – a shift from a fixed median-price system to a market-based exchange-rate package – a step further, adding 11 currencies to the renminbi’s reference currency basket. With that, China’s exchange-rate storm subsided, and a two-way...

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