The Devaluation of the Yuan: China’s Economic Tightrope

Anna Kim, Jun 23, 2024

Currency devaluation is a double-edged sword—providing nations with an opportunity for economic growth or a potential plunge into disaster—which China currently faces as domestic and international tensions rise. Economists predict a massive devaluation of China’s national currency as gold and oil investments soar and the strength of the U.S. dollar threatens to launch a currency war. The devaluation of the yuan would be a nuclear option, especially considering China’s recent affiliations with Moscow amidst the ongoing Russo-Ukrainian War and Chinese reliance on exports as a nation in a strong external trade position. There appears to be little benefit in intentionally devaluing the yuan, and with President Xi Jinping’s departure from collective leadership practices in favor of assertive self-centralization, it appears that this burgeoning “nuclear option” could leave China in an economic, political, and social dilemma. Though technical solutions such as an easing of monetary policy and a temporary return to a hard-peg economic system are necessary, it is Xi’s concentrated focus on power retention that demands reform, enabling China to return to a state of economic stability it so desperately needs.


Economic Background

Against the backdrop of the Chinese economy’s recent underwhelming growth, the yuan has depreciated approximately 8 percent against the dollar since January 2023 [1]. External demand for exports has waned by 7.5 percent from the same time last year [2] and other failures in China’s real estate and local governments have sparked worry amongst states who rely on Chinese exports within the Global Trading System, where China accounts for more than 18 percent of the world’s GDP [3]. This depreciation can be traced back to several causes, including rate slashing by the People’s Bank of China, an outflow of capital, and a lack of fiscal stimulus, all of which contribute to dropping interest rates and the trickling departure of foreign investors.


International and Domestic Impact

Though China has slowed in its path to surpassing the United States as a global power, it still stands as one of the strongest and most influential states in international politics and the world economy. Economists have taken note of China’s recent accumulation of gold and oil as a sign of the potential devaluation, with former International Monetary Fund official Eswar Prasad stating that these purchases “are likely to be driven by domestic policy risk, as a way of moving capital out of the Chinese financial system” [4]. This diversification may also be a response to the economic blow Russia took after its invasion of Ukraine in 2022, with such attempts at establishing independence from the U.S. dollar through commodity acquisition providing China with some financial security and global bargaining power—crucial to helping stabilize a country on the brink of a potentially devastating devaluation. China has seen its foreign policy scrutinized since Russia’s initial invasion of Ukraine and continues to maintain strong ties with Moscow. Although Beijing has not publicly supported Russia through military means, the war has had minimal impact on the countries' bilateral relations, as evidenced by their economic reliance on one another—though Russia depends significantly more on China than vice versa [5]. This has become a recent concern for Moscow as Putin attempts to transition away from reliance on the U.S. dollar with China’s potential currency devaluation undermining the yuan’s appeal relative to the dollar—which Russia is aiming to topple [6]. However, the United States and other Western countries are not happy either, with a devaluation set to worsen ongoing trade frictions caused by the yuan’s ongoing depreciation. China is also likely to receive hostile reactions from the U.S. and E.U.—especially under a potential Trump administration in 2024. 


Devaluing the yuan could also have detrimental impacts on the domestic economy. China’s real estate system is suffering after the liquidation of development giant Evergrande in 2021, which still remains $300 billion deep in investor debt. The country also continues to face ongoing issues concerning declining consumer and international demand for products. Domestic spending is low due to a lack of established economic safety nets, unemployment rates have surged, and the national pension fund is expected to run dry by 2035 [7]. A devaluation would only serve to worsen inflation and harm domestic businesses that rely on imports or cater to an exclusively Chinese consumer base. Alongside ongoing wage cuts resulting from the aforementioned collapse of China’s export and real-estate bubble, a devaluation or even further depreciation of the yuan by itself is nothing but bad news for the country’s domestic economy. 


The Impact of President Xi Jinping’s Policy

Though this suspected devaluation is a rather recent occurrence, analysts cite Xi’s policy approach, with his focus on centralization and retention of power, as the fundamental issue behind the state of China’s economy. Chinese political analyst Neil Thomas argues that Xi’s “three balancing acts”—economic growth with security, diplomatic struggle with avoidance of economic “decoupling”, and “competition between sub-factions in elite politics,”—were temporarily beneficial but have led to major long-term losses [8]. Furthermore, Xi is arguably the most powerful leader in the history of the People’s Republic of China, and his strategic elimination of factional rivals since his election in 2013 has shifted China’s policy-making model from consensus-based to a top-down ladder with Xi in command [9]. This consolidation of power can especially be seen within China’s foreign policy and Xi’s creation of several national security and foreign affairs commissions, through which Xi has established the institutional capacity for China to dominate global politics. Under Xi, China has become an increasingly nationalist and isolationist country that seeks to skirt dependence on the Western economy. Foreign business operations have gradually become more difficult to maintain, and Xi’s neglect of Chinese consumers’ economic stability has only worsened the national economic condition [10]. Economies flourish with freedom and innovation, and the effects of  Xi’s concentrated control over policymaking and the economy have come to a head with this looming devaluation. 


It would be irresponsible to not consider the possibility that this is an intentional political move by Xi, especially considering the state of international politics and China’s position as a global power. However, this appears extremely unlikely. Xi’s “one-man government” already struggles under intense, pointed criticism which makes it unlikely that a major devaluation—with its resulting severe backlash—would be used as a scare tactic only. Posturing has recently been observed in foreign relations, such as South Korea’s diplomatic talks with Cuba—essentially meaningless outside of their potential to unsettle North Korea—but the enormous domestic and international devastation caused by a devaluation appears far too significant to attribute to political manipulation or any minor benefit to Chinese exports [11].


Short-Term Solutions

To alleviate the social, political, and economic fallout of a potential devaluation, a temporary switch to a hard-peg monetary system—in which the government’s central banks establish a fixed exchange rate—in tandem with attempts to boost customer spending could act as a short-term solution. Through state intervention, a fixed currency rate for the yuan could stabilize its value to approximately 7.3 yuan to the dollar, slow its depreciation, and increase the appeal of Chinese exports on the global marketplace, which is critical to addressing the lack of confidence domestic consumers currently have in the Chinese economy [12].  During their 2009-2011 economic recession, Estonia used a similar strategy that involved pegging its currency to the euro while introducing structural reforms that eventually stabilized the economy, which meant that the country faced only an internal devaluation due to a lack of monetary independence [13]. China’s external trade surplus [14] is another issue, with a lack of domestic consumption forcing the country to export everything that its government, businesses, and households cannot consume —$890 billion as of 2022 [15]. Addressing the excessive savings of the Chinese public is paramount to rebalancing the economy, but it’s a daunting task that requires a strengthening of local finances—where most of China’s debts lie—and the expansion of limited social and economic safety nets, both long-term solutions that rely on sweeping reform centered around President Xi Jinping’s policymaking [16]. 


Power is concentrated in the hands of the president, and this will only continue to harm the Chinese economy if changes are not made. Xi’s hyperfocus on competing with the U.S. in manufacturing and growth has created production overcapacity that worsens political tensions. His top-down policy approach and drive for middle-class-targeted “common prosperity’ have backfired in the face of economic struggles. At this point in time, China’s economy will benefit the most from changes to Xi’s policy stance that redirects focus from centering China in the global economy and international politics—therefore “decentering” the U.S.—to bolstering its private sector, therefore boosting investor confidence and reinvigorating entrepreneurship. However, the recent unveiling of China’s economic blueprint that highlights productivity centered on green energy, artificial intelligence, and technology does not promise reform any time soon.


Special thanks to Professor Eric Min.


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