You Don’t Know Zhou

Pundits can argue about devaluation versus market forces. But only one man knows for sure what the People’s Bank of China was up to when the value of the renminbi fell last week.


What’s going on at China’s central bank? The People’s Bank of China, led by Governor Zhou Xiaochuan, has been slowly liberalizing currency and capital markets for several years now. Last week, though, it made a monetary policy move that surprised people around the world. A week later, those same people can’t seem to agree on what it means.

The central bank has long allowed the exchange rate of the dollar and the renminbi, China’s currency, to move within a band that has gotten slightly wider from year to year, until reaching its current range of 2 percent on either side of a fixed opening rate. But on August 11, for the first time, the bank began to let the band move in an apparently market-driven way from day to day. Every morning when trading began, the midpoint of the new band would be similar to the closing rate from the previous day.

Over the next three days, the renminbi, also known as the yuan, lost about 3 percent of its value against the dollar. Western observers immediately cried foul, accusing China of devaluing its currency deliberately in an attempt to make its exports cheaper and boost its flagging economy. It was a “race to the bottom” or “beggar-thy-neighbor” economics — the sort of thing that used to lead American politicians to accuse China of manipulating its currency.

Yet some China hands doubted this explanation. They pointed out that Beijing has been trying to gussy up the renminbi in advance of the International Monetary Fund’s (IMF) decision in November on whether to include the yuan in the basket that forms its own distinct currency, the Special Drawing Right. Inclusion would make little difference to China’s economy in itself, but it would be a stamp of approval that the renminbi was on its way to being “convertible” — freely usable and tradable around the world. The experts said China had taken a step toward allowing the renminbi’s value to float on its own, and market forces had pushed down its value versus the dollar.

The clash between these two stories even pitted colleagues against each other. At the Peterson Institute for International Economics in Washington, D.C., Nicholas Lardy blogged that China’s move was a “potentially major step” towards a free-floating currency. He followed up with another post asserting that the Chinese economy wasn’t as weak as other experts believed, implicitly arguing that there was less reason for the government to want a devalued currency that would boost exports. But Adam Posen, the institute’s president and a former member of the Bank of England’s Monetary Policy Committee, said he thought the devaluation was intentional — though he hoped Lardy was in fact correct.

Who’s right? The only way to know the Chinese central bank’s true intentions is to find out exactly what it was up to last week. If the bank was injecting renminbi into the market in order to increase its supply, then the fall in the exchange rate was probably deliberate. But if the bank was sucking renminbi out of the market all along in order to support the currency — and then stopped last week — then the dip was just the currency finding its fair value. In that case, any boost for exporters was just a convenient bonus.

Getting the whole truth seems simple enough, in theory. Anyone could just look at what happened to the bank’s reserves during the week to see whether it was buying or selling assets denominated in different currencies. There’s just one problem — the People’s Bank doesn’t publish the makeup of its reserves, just the total, and that number only comes out monthly. So whatever the bank did could be masked by movements in the values of other currencies and by its interventions at other times of the month. Some reports suggested the bank tried to prop up the renminbi at the end of each trading day, perhaps to ensure the band for the next day wouldn’t be too low, but the rate still dropped.

So it’s back to square one: Pundits can claim all the expertise they want, but the answer still has to come from the mouth of a Chinese central bank official. And the bank is sticking with the market forces story. On Thursday, its officials called a news conference to say the currency wasn’t undervalued and was unlikely to drop further. Right on cue, the renminbi gained slightly against the dollar the next day. But was the central bank intervening in the market to cover its tracks? We may never know. The IMF is standing behind China and asking for more steps to relax control of the exchange rate, such as removing the band altogether and making interventions less frequent. Others continue to doubt that market forces are driving the renminbi’s plunge.

Either way, this episode is likely to be a footnote in Chinese economic history. The overall trends are more liberalization of currency and capital flows, and more focus on domestic demand rather than exports. Between June 2005 and January 2014, the renminbi steadily gained more than 25 percent against the dollar, except for a period of enforced stability around the time of the global financial crisis. Lately, despite a relatively wide band for trading, the exchange rate has moved less dramatically, leading many economists to conclude that the currency is near its fair value. In the meantime, use of the renminbi in trade and investment has increased markedly, and capital markets in China have begun a broader opening to private investors at home and abroad. These trends aren’t going to change anytime soon, no matter who’s right about the central bank’s current approach.

Still, plenty of people are still betting on short-term currency moves, and stock markets around the world are reacting to the prospect of more globally competitive Chinese exports. That’s why some of these experts have jobs. Before 1990, they called it Kremlinology, and it was a booming business for academics, think-tankers, and journalists alike. So it’s a good thing a Communist Politburo still runs the People’s Republic of China, and the central bank still operates largely in secrecy — if they didn’t, all those tea-leaf-reading skills would go to waste.

Feng Li/Getty Images

 Twitter: @altmandaniel
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