China’s Central Bank Is in a Terrible Bind

Headquarters of the People's Bank of China, the central bank, is pictured in Beijing on Dec. 13, 2021. Andrea Verdelli/Bloomberg via Getty Images

Commentary

Donald Trump’s election complicates Beijing’s already fraught policy agenda. Even before Trump secured the White House, the People’s Bank of China (PBOC) was in a policy bind.

On one side, China’s severe economic and financial problems demanded stimulative monetary policies replete with lower interest rates and generous flows of liquidity into financial markets. At the same time, national pride and Chinese leader Xi Jinping’s ambitions for the yuan’s global stature demanded that the central bank support the currency’s foreign exchange value with just the opposite set of policies.

Trump’s promise to raise tariffs on Chinese goods entering the United States has placed the PBOC under even greater pressure. So far, monetary policymakers have shown little conviction in sorting through these pressures.

To date, the PBOC seems to have done a little of each sort of policy stance. This effort to do two opposite things at once has served neither need adequately. For the sake of China’s beleaguered economy, the central bank has eased monetary policy, but for the sake of yuan support, it has moved in painfully small and slow steps. It began this process in 2022, when it first became apparent that China’s economy needed help.

Early that year, the PBOC’s benchmark loan prime rate stood at 3.8 percent. In the years since, the central bank has brought that rate down to 3.1 percent, for a total drop of 0.7 percentage points. This is hardly the kind of move needed by an economy in the throes of a property crisis, local government financial distress, and an array of other negative economic trends. The inadequacies of the PBOC’s tiny moves are painfully evident in China’s ongoing economic and financial troubles.

Nor did this excess of caution do much to save the yuan’s stature on the world stage. Especially because during this same time, the Federal Reserve’s (Fed’s) fight against inflation in the United States pushed the Fed’s benchmark federal funds interest rates up by two full percentage points, making dollar holdings increasingly more attractive than yuan holdings. Accordingly, the yuan fell by some 15 percent from 6.3 to the dollar in early 2022 to about 7.3, lower than any time in the past 17 years.

This decline in the yuan’s value has severely undermined Xi’s ambition to elevate the yuan’s global status and to make the currency a worldwide medium of exchange and a preferred reserve holding for central banks and international businesses. The yuan’s lost value has embarrassed Xi’s insistence that some of China’s trading partners denominate import and export contracts in yuan instead of dollars.

It has become even more embarrassing as China and other members of the so-called BRICS—Brazil, Russia, India, and South Africa—try to develop an alternative to the U.S. dollar as a basis for trade and international finance. The declining status of the yuan was clearly evident in how investment banks in Saudi Arabia insisted that Chinese bonds issued there be listed in dollars instead of yuan.

Now, against this background of failure, Trump’s tariffs loom on the economic and financial horizon. If the experience of his earlier tariff impositions in 2018 and 2019 is any indication, new higher tariffs will put still more downward pressure on China’s yuan. Of course, a drop in the dollar value of China’s currency will bring down the dollar cost of Chinese products to American buyers.

The effect will sustain the flow of Chinese exports despite the tariffs. That is what happened six years ago. However, because Chinese producers will get fewer dollars for their products, the currency loss will show in reduced revenues, profits, and global wealth.

If, as is likely, this currency adjustment happens again, it might protect Chinese exports and, to an extent, the Chinese economy from further downward pressure. Still, it will severely set back Xi’s ambitions for the yuan’s global status and all the diplomatic and economic stature that presumably would accrue to China if he could fulfill those ambitions. And it would still leave the PBOC facing the need to help a troubled Chinese economy.

Views expressed in this article are opinions of the author and do not necessarily reflect the views of The Epoch Times.