China’s Yuan Weakens

After months of trying to energize the yuan, the People’s Bank of China has exhausted most of its policy tools, leaving it with some hard choices.

The yuan now trades at 7.24 against the US dollar, a softer position brought on by a 12% rally in the American currency this year that has pushed the yuan close to the weakest extremes of its trading band.

The more the yuan struggles, the more the likelihood of extreme measures looms into view. Already there are signs that China is intervening in foreign exchange markets, like Japan has done. 

Other drastic measures include a one-time revaluation of the yuan, an aggressive move that could be a detriment to China’s hopes of internationalizing its currency.

Almost every measure available to China will likely have a downside that includes draining the country’s foreign reserves and giving the country the reputation of a heavy-handed closed market. 

It has been tough for most countries to rally against a strong dollar this year. The greenback has steamrolled almost every other currency, casting the yuan’s relatively modest slide in a good light.

One defense mechanism China has rolled out has been to give state-owned banks the ability to sell dollars, which firms have snapped up in favor of the yuan, as it makes their import spend more predictable.

The obvious drawback of this approach is that it erodes China’s foreign exchange reserves, a situation the country would rather avoid in case of another financial shock.