China's Weakness, Tech War Push Yuan Toward Multi-Year Lows — Where Is It Heading Next?

China's persistent economic weakness and the escalation of the tech war between Washington and Beijing continue to drive the country's currency, the RMB (Yuan), lower, according to Dr. Tenpao Lee, professor emeritus of economics at Niagara University.

"Fundamentally, the value of a country's currency reflects the strength of its overall economy in general," Professor Lee explained. "For example, China's economy in the post-pandemic era was in deep trouble with higher unemployment rates, collapsed real estate sectors, and dramatic capital outflows. As a result, China's currency, the Yuan, has significantly depreciated in the last two years, and all assets denominated in Yuan have become cheaper. To make matters worse, the ongoing chip wars and geopolitical factors will add more constraints and limit China's role in the global economy."

Professor Lee's comments follow a series of declines in the value of Yuan against the dollar. It recently traded 7.23 yuan to the dollar, near a 16-year low.

Tor Langoy, President and CEO at BD Globe Financial, sees the weaker yuan as the result of Beijing's efforts to stimulate exports. "It's a deliberate policy from the Chinese leadership as exports stay competitive and get cheaper, with lower Yuan to the USD," he said, adding, "Also, it will attract (theoretically at least) more capital inflows as Chinese assets will be cheaper."

Juscelino F. Colares, professor of international business law at Case Western Reserve, agrees. "This may not be all bad news, but it makes Chinese exports more competitive, which should boost its economy," he stated.

Thus far, the weaker Yuan has served Beijing's foreign currency policy. China's exports surged at an annual rate of 7.1% to $528.01 billion in January-February 2024 combined, following a 2.3% gain in December 2023.

Professor Colares believes this situation may not be sustainable if the Fed abandons its promise of three rate cuts by the end of the year (read the November presidential election). In such a scenario, the Yuan is likely to appreciate against the dollar, potentially altering the current economic landscape.

Professor Lee sees things worsening for the Chinese yuan, as elevated inflation will slow down the global economy, hurting Chinese exports.

"China is the largest manufacturer in the world," he explained. "China was critical in the global supply chains before the pandemic. The global economy is likely to decline with higher inflation levels if China is excluded from the post-pandemic recoveries."

In addition, China's Yuan will continue to be under pressure from the interest rate spread, the difference between China's and the U.S. interest rates. This spread determines the direction of capital flows between the two countries in favor of the country with higher interest rates.

Currency investors and traders go long on the currencies of countries with high interest rates and short on those with lower interest rates, which is the case here.

Currently, the 10-year U.S. Treasury bond has a yield of 4.22%, almost twice the corresponding Chinese Treasury bond, which has a yield of 2.31%.

If this yield gap persists, capital will continue to flow out of the Yuan and into the dollar, exerting downward pressure on the Yuan. The yield gap affects China's economy and has implications for global markets, underscoring the significance of this economic analysis.

"This time is different, the adage says," Professor Colares said. "But it does capture the current pickle in which China's central bankers and China find themselves. As they ease monetary policy to give the economy a boost, a decline in foreign direct investment due to, among other things, decoupling, China's loss of access to latest generation chips, and Japan's ending of negative interest rates mean that forces that previously pushed the Yuan up are abating. "

Professor Lee sees tremendous pressure ahead on China to solve all its challenges. "It has probably been the most difficult time for China since 1978 when China opened its doors to the world," he said.

"Therefore, while China is responding with new strategies to revive its economy, China's currency, the Yuan, will fluctuate between 6 and 8.25, i.e., 1 USD may exchange to Yuan, a historical range in the last 20 years," the professor added.