1. NS3040 Fall Term 2017 Chinese Currency Movements: February/March 2014
Federal Reserve Bank of Chicago, Strong Dollar Weak Dollar

2. Chinese Currency Movements I
Late February 2014 China’s yuan fell steadily against the U.S. dollar
Appears the Chinese central bank deliberately pushing the currency lower
Why the sudden devaluation?
Currently yuan trades within a tight range set by the central bank every day
Short-term traders and increasing demand almost constantly pushing currency higher within that range
By devaluating the currency’s value the central bank is trying to discourage (one way) speculation on the currency
With fewer speculators trading in the yuan China hopes to have an easier path to widen the yuan’s trading range further
In longer term make the yuan a free-floating currency
Erin McCarthy, Why the Yuan’s Decline Matters, WSJ, February 26, 2014

3. Chinese Currency Movements II
Lingling Wei, China Intervenes to Lower Yuan, WSJ, February 27, 2014

4. Chinese Currency Movements III
Why does China want to free its currency in the long term?
Having a freely traded currency makes it easier for the yuan to become more prominent in trade and payments internationally
A freely convertible currency also makes the yuan a more attractive reserve currency for Central Banks
Other reasons –
China is trying to push its economy away from relying so much on exports and investment
Instead it wants more of its growth to come from domestic demand
Making the yuan behave more like a market driven currency fits into this broader plan.
Erin McCarthy, Why the Yuan’s Decline Matters, WSJ, February 26, 2014

5. Chinese Currency Movements IV
More conjectural reason:
Concerns over shadow banking operations
Since December 2012 the People’s Bank of China (PBoC) has tried to limit activities in the shadow banking sector
Aim is to prevent high-interest loans from triggering a wave of defaults among local government borrowers
Such efforts have not been effective
Shadow Loans (entrusted loans) rose to $64.7 billion in January almost double that in January 2013
Avoiding the central bank’s pressure to liquidate shadow financial assets (which offer attractive returns) banks are opting to sell off lower yielding enterprise bonds (debt issued by state- owned companies)
Result – raising cost of financing to companies and local governments.
James Kynge, Beijing Guides Renminbi Lower in Effort to Manage Financial Risks,” Financial Times, February 27, 2014

6. Chinese Currency Movements V
These actions squeeze the supply of credit to the “real” economy while shadow finance segment is nourished by inflows of capital that slip through holes in the country’s capital account
Steps in the yuan carry-trade
Borrow abroad at around 1.0% interest
Change money into yuan and bring it to mainland
There receive 10 to 12% by lending it to a trust or
20% by putting it with an underground bank
On top of that capered the expected yuan appreciation
Evidence
Signs of over-invoicing of exports
44% in survey felt that fake invoicing was on the increase
James Kynge, Beijing Guides Renminbi Lower in Effort to Manage Financial Risks,” Financial Times, February 27, 2014

7. Chinese Currency Movements VI
Summing up
PBoC wants to stifle one way bets on yuan
If successful will slow speculative activity and with it destabilizing capital inflows.
Bank knows that if it were to try to stop inflow of illegal capital entirely it might trigger a wave of financial defaults it has been trying to avoid in the first place
Gradual approach using exchange rate flexibility to generate a market response seems to suit Bank’s objectives for now
James Kynge, Beijing Guides Renminbi Lower in Effort to Manage Financial Risks,” Financial Times, February 27, 2014