The Yuan's Undervaluation and Its Impact on Global Trade Imbalances

The Chinese yuan (CNY) remains a focal point of global economic debate in 2025, with mounting evidence of its undervaluation reshaping trade dynamics and investor strategies. Using the Bank for International Settlements (BIS) real effective exchange rate model, the CNY is estimated to be undervalued by approximately 30% relative to its trade partners, a figure corroborated by the International Monetary Fund’s 8.5% undervaluation estimate and the Brookings Institution’s 20% assessment [1]. This undervaluation is driven by China’s low inflation rates compared to the U.S. and Europe, as well as its managed floating exchange rate regime, which allows the People’s Bank of China (PBOC) to resist upward pressure on the yuan despite trade tensions [2].

Strategic Currency Interventions and Global Trade Flows

China’s strategic interventions—ranging from foreign exchange reserves to capital controls—have amplified the yuan’s undervaluation. The PBOC has actively managed the currency by accumulating foreign assets and maintaining a weaker yuan against the euro, which has contributed to a growing trade deficit in the euro zone. German studies highlight that this undervaluation provides Chinese exports with an “unfair” cost advantage, undermining European firms and distorting global trade balances [3]. Meanwhile, the yuan’s resistance to appreciation against the U.S. dollar, despite U.S. tariffs on Chinese goods, has shifted export flows to Europe, with Chinese exports to the euro zone increasing by 11% in 2025 [4].

Implications for U.S. and European Investors

For U.S. investors, China’s currency policies have created a dual challenge. While the PBOC’s management of the yuan has stabilized its value against the dollar, U.S. inbound foreign direct investment (FDI) into China has plummeted from $144 billion in 2020 to $4 billion in 2023, driven by restrictive regulations, cybersecurity requirements, and geopolitical risks [5]. The U.S. administration’s aggressive tariff policies have further complicated trade dynamics, pushing European markets to absorb a larger share of Chinese exports. This shift has led to increased Chinese investments in Europe, particularly in high-tech sectors like electric vehicles and batteries, raising concerns about U.S. economic and security interests [6].

European investors face a different set of risks and opportunities. The euro zone’s trade deficit with China has widened as the yuan’s undervaluation makes Chinese goods more competitive. However, China’s growing economic ties with Europe—exemplified by its outward direct investment (ODI) in Southeast Asia, Latin America, and the Middle East—have also created new investment corridors. European firms are recalibrating their exposure to Chinese assets, balancing the benefits of diversification against the risks of geopolitical tensions and regulatory unpredictability [7].

The Path Forward

The yuan’s undervaluation is not merely a technical issue but a strategic lever in China’s economic model. By maintaining a weaker currency, China sustains its export-driven growth while managing domestic demand. However, this approach risks exacerbating global trade imbalances and intensifying scrutiny from U.S. and European policymakers. For investors, the key lies in navigating the evolving regulatory landscape and understanding how China’s currency interventions will shape future trade flows.

Conclusion

The yuan’s undervaluation underscores the complex interplay between currency management, trade policy, and investor behavior. As China continues to refine its exchange rate strategy, U.S. and European investors must remain vigilant to the shifting risks and opportunities in a rapidly evolving global economy.

Source:
[1] The Curiously Unpopular Case for RMB/CNY Appreciation, [https://www.vaneck.com/be/en/blog/emerging-markets/the-curiously-unpopular-case-for-rmbcny-appreciation/]
[2] China Urged by Think Tanks to Strengthen Yuan Amid Trade Tension, [https://www.bloomberg.com/news/articles/2025-08-14/china-urged-by-think-tanks-to-strengthen-yuan-amid-trade-tension]
[3] China's Yuan Undervaluation Fuels Euro Zone Trade Deficit, [https://www.reuters.com/world/china/chinas-yuan-undervaluation-fuels-euro-zone-trade-deficit-german-study-shows-2025-07-23/]
[4] China's Global Investment Surge: Strategies and Economic, [https://discoveryalert.com.au/news/china-global-investment-strategy-2025-economic-objectives/]
[5] 2024 Investment Climate Statements: China, [https://www.state.gov/reports/2024-investment-climate-statements/china]
[6] Will the United States Push Europe Toward China?, [https://www.csis.org/analysis/will-united-states-push-europe-toward-china]
[7] The Implications of U.S.-China Trade Tensions for the Euro Area, [https://www.ecb.europa.eu/press/economic-bulletin/focus/2025/html/ecb.ebbox202503_02~b2916b44db.en.html]