Chinese Yuan Weakening: A Looming Threat Amid Trump Trade Risks

Chinese authorities are reportedly considering a weaker yuan as a potential strategy to mitigate the impact of potential U.S. tariffs under President Trump, according to sources familiar with the matter. This move could make Chinese exports more competitive, but it may also exacerbate capital flight and global trade tensions.

The yuan has been under pressure in recent months, with the Chinese central bank allowing it to depreciate against the U.S. dollar. The yuan's value relative to Asian rivals like the yen has also fueled devaluation talk, as the yen has slipped to its weakest level against the U.S. dollar in decades. This has placed China in a currency-market Catch-22, as efforts to slow the yuan's depreciation against the dollar have allowed the currency to strengthen against a trade-weighted basket of mostly Asian rivals.

A weaker yuan would enhance China's export competitiveness by making its goods cheaper for foreign buyers. This could boost exports and stimulate economic growth. However, it may also lead to higher import prices, contributing to domestic inflation. Chinese authorities have plenty of ammunition to continue the yuan's weakness against the dollar, but continuing to resist yuan weakness could hamstring their efforts to revive their domestic economy.

The latest GDP figures released by the Chinese government showed the world's second-largest economy expanded at a 5.2% pace during 2023. However, some economists have questioned their credibility. An extreme step, such as a sudden devaluation of the yuan on par with what happened in 2015, would be a risky move for China. Even then, a devaluation could help China inflate away its bad debts following the implosion of a real estate bubble that rocked China's domestic economy. However, an abrupt devaluation could risk instigating a trade war that might destabilize global markets.



China's exports face multiple headwinds, including growing resistance in developed countries and some developing countries to accommodating a surge of exports from excess production. This means protectionist policies are on the rise worldwide, and China's exporters are likely to face higher tariffs and greater restrictions to their market access in years to come. Compounding these headwinds, China has signaled its willingness to let its currency, the renminbi (RMB), weaken against a strengthening dollar. This move is reflected in the Chinese central bank's daily fixing of the RMB, also called the yuan.



China's quandary is a peculiar one. Superficially, the RMB looks as though it ought to be rock-solid, with a healthy current account surplus and a positive net international investment position. However, China's current account has been shrinking, and its dependence on exporting its way out of domestic economic morass is at greater risk than it first appears. Measures such as the European Union's Carbon Border Adjustment Mechanism (CBAM) could hit China's exports harder than those of other countries. Additionally, China's chronically weak domestic consumption, collapsed property market, and rising demographic cost at home are inducing Chinese exporters to move offshore, reducing the value added that takes place in China and replacing export earnings with profit streams from overseas.

In conclusion, a weaker yuan could provide a temporary boost to China's export competitiveness, but it may also exacerbate capital flight and global trade tensions. Chinese authorities must carefully weigh the potential benefits and risks of such a move, as the global economic landscape remains uncertain and volatile.