by Nomi Prins
The Chinese government grew anxious. China’s growth rate had fallen from the first quarter to 8.1 percent, the slowest economic activity since the summer of 2009.107 However, inflation and potential asset bubbles remained concerns.
And although the yuan had steadfastly appreciated, that still wasn’t enough for the United States, which maintained its public crusade against China’s exchange rate policy. The Fed demanded monetary policy supremacy and collusion over conjuring money. The PBOC wanted to chart its own path.
In September 2012, the Fed embarked on its third round of quantitative easing (QE3). It claimed this was because of poor economic recovery, but major US banks were struggling under the scrutiny of their practices by prosecutors during the financial crisis. And it was an election year. The Fed tended to favor the party in power, though it theoretically operated as an independent entity. It also protected the biggest banks. Emergent countries saw this US monetary policy as irresponsible, fostering financial instability in the guise of promoting an economic recovery whose goal line kept changing.
On October 10, Zhou did not appear at the IMF meetings in Tokyo as expected—officially, because of a scheduling conflict but ostensibly because of the disputes between Japan and China over the islands in the East and South China Seas.108 His deputy Yi Gang went instead. Rumors about Zhou’s absence intensified after representatives from China’s four major banks—the Industrial and Commercial Bank of China, Bank of China, China Construction Bank, and Agricultural Bank of China—chose not to attend the meetings either in protest of the territorial dispute.
Whenever things got complicated between China and Japan, the populations resumed their rivalry. In comparison, Japan and the United States had complementary economies and their central banks collaborated. A more prominent China could shift the balance of power in the region, resulting in loss of influence of Japan and, by extension, the United States.
On October 11, 2012, for the first time in nineteen years, the yuan rose to 6.28 per dollar as investors speculated on coming artisanal measures to revive economic growth in China.109 It was the yuan’s strongest level since China unified market exchanges in 1992. A month later, Zhou declared inflation was the main risk for China while again promising to transition to a more market-based economy with deeper financial reforms. “On the one hand, we need to maintain a healthy economy, but we also feel deeply that the People’s Bank of China must push forward reforms and opening up.”110
At the Caixin Summit on November 17, Zhou further explained his integrated philosophy.111 “It is the central bank’s job to maintain the health and stability of all key economic indicators while supporting the government’s reform agenda… the risk of high inflation looms at all times, and the central bank should always be on guard against it.”112 By that time, China’s inflation rate had fallen after the PBOC’s two-year fight to return it to the 4 percent government target.
China continued poking holes in US and ECB money-conjuring policy. The PBOC’s third-quarter report for 2012 noted “a by-product” of the Fed’s third round of QE could be “excessive liquidity which could lead to large fluctuations in cross-border capital, price hikes of international commodities and eventually growing inflationary risks.”113
On November 27, given mounting geopolitical tensions around the South China Sea, the US Treasury Department again accused China of maintaining the yuan as “significantly undervalued.”114 It represented a step backward in diplomatic relations. Although the yuan had appreciated 12.6 percent against the dollar since mid-2010, the Treasury insisted Beijing allow more flexibility in its exchange rate. “The available evidence suggests the [yuan] remains significantly undervalued, and further appreciation of the [yuan] against the dollar and other major currencies is warranted.”115
The Chinese Embassy did not respond to the Treasury’s comments. Chinese policymakers had always defended what they called the equilibrium of the yuan in relation to the economic activity level, which meant they believed (or affirmed believing) the yuan didn’t have much room to appreciate. Facing their own losses, many US unions and lawmakers complained about the yuan’s value and China’s advantage in foreign markets.
The US Treasury refrained from officially labeling China as a currency manipulator as a way to minimize the importance of China’s domestic intentions as well as its growing prominence on the world stage, which involved currency speculators and free market pressures on the currency as well. That worsened diplomatic tensions without any guaranteed remedy.
YEAR OF THE SNAKE
The weaker economic situation in China invigorated steps toward structural reforms. The incoming government—composed of Xi Jinping as president and Li Keqiang as premier—appeared at the Third Plenum in November 2013, pledging to allow market competition to influence the economy. “The focus of the restructuring of the economic system… is to allow the market [forces] to play a ‘decisive role’ in the allocation of resources,” they said.116
Despite the shift in government leadership from Wen Jiabao to Li Keqiang on March 15, 2013, Zhou kept his spot as governor of the PBOC for a third term. According to the Wall Street Journal, “Even though he had passed the mandatory retirement age of 65[,] Zhou was at the zenith of his influence, as the new leaders embraced reforms that Mr. Zhou had been pushing for years, including letting the market set interest rates and removing barriers to the flow of capital into and out of China.”117 Zhou had proven himself resilient and politically savvy.
He had led the reform initiatives rendering China better adapted to market demands and had become well known by international market players. In 2011, Euromoney magazine had named Zhou the central bank governor of the year.118 He was the only Chinese official to be part of the select Group of Thirty.119 His consistent international reputation and alliances contributed to China’s acquisition of superpower status.
Zhou pursued financial reform policies that liberalized the currency market. He broke the peg of the yuan to the US dollar, a step necessary to launch the yuan as a global currency. Keeping him at the helm of PBOC signified these reforms would continue.120 During the year, the yuan overtook the euro as the second-most-used currency in international trade and finance, just behind the US dollar.
The 2012 US presidential campaign was marked by Mitt Romney accusing Barack Obama of not labeling China a currency manipulator.121 When called to speak before the Senate on February 13, 2013, Jack Lew, Obama’s new Treasury secretary, said he believed the yuan was “still undervalued” but sidestepped the question from Ohio Democrat senator Sherrod Brown of whether he would endorse the bill passed in 2011 that permitted the United States to slap duties on goods from countries with undervalued currencies.122 Later, at the same hearing, Lew said that “addressing China’s exchange rate would be a top priority” and that, if confirmed, he would “press China to move to a market-determined exchange rate, level the playing field for our workers and firms, and support a sustained shift to domestic consumption-led growth in China.” He promised to work with Congress on the issue but still didn’t endorse the bill. Obama won the election easily to assume his second term.
Ma Kai (vice premier), Lou Jiwei (minister of finance), and Zhou Xiaochuan (reappointed as governor) all assumed office on March 16, 2013. Five days later, China launched its most important economic reform program since the 1990s, after allies of former premier Zhu Rongji were put in charge of key economic agencies.123 Zhu had been the architect of the economic reforms that prompted China’s entrance into the World Trade Organization in December 2001 and he was attributed partial credit for China’s economic success.
BRICS RISING
China was making strides internationally, too. On March 27, 2013, during a meeting in Durban, South Africa, the BRICS countries’ leaders approved a $100 billion fund to confront currency crises, though they failed to reach a financing agreement for their development bank.124 Russian prime minister Dmitry Medvedev said China would likely provide the largest amount of money for t
he foreign currency pool.
According to President Xi Jinping, the group “reached broad consensus” to “further unlock potential cooperation.” Discussions about the associated development bank had begun a year before, when India proposed it amid criticisms that the World Bank and IMF were not fully committed to the economic and financial welfare of emergent countries.
On March 31, 2013, the yuan hit a nineteen-year high at 6.210 after the PBOC raised the daily reference to the strongest level in more than ten months.125 Some analysts argued that Xi Jinping’s first international visits as president drove the yuan’s appreciation, especially because he was meeting the BRICS’ and other emergent countries’ leaders. The world stood eager for a non-US-based (or US-directed) development bank.
A few weeks later, the Obama administration announced it would monitor Japanese economic policies to ensure they were not devaluing the yen to increase competitiveness.126 In the same report, the United States said China still undervalued its currency, though this was not characterized as an act of currency manipulation, legally. The US Treasury Department was adamant but refrained from using the term “currency manipulator,” noting, “The available evidence suggests the renminbi remains significantly undervalued, intervention appears to have resumed, and further appreciation of the renminbi against the dollar is warranted.”127
The US Business and Industry Council condemned the currency report and urged US president Obama to use tariffs to punish China for the yuan’s manipulation, stating, “The Treasury Department’s latest refusal to label China a currency manipulator once again demonstrates President Obama’s deep-seated indifference to a major, ongoing threat to American manufacturing’s competitiveness, and to the US economy’s return to genuine health.”128
Zhou had to placate US strife even though the yuan was hardly devalued from an historical perspective. On June 17, 2013, the yuan rose after the PBOC raised the reference rate to an historical record of 6.1598.129 Governor Zhou told China Central Television that the PBOC would not intentionally depreciate the yuan to foster exports. China’s industrial output growth compared to a year earlier slowed to 9.2 percent. Exports had increased, but more slowly, since the beginning of the year, and factory gate prices had fallen for the fifteenth month.
On October 9, President Obama officially nominated Janet Yellen to succeed Bernanke as chair of the Fed.130 The Fed was pumping $85 billion a month into the economy through QE. It was no accident that Yellen was a key supporter of Bernanke’s money-conjuring policies. (She was confirmed on January 6, 2014, and through December 2015 didn’t hike rates one bit.)
October was a busy month for China in terms of outreach to other countries. The PBOC jumped into the money-conjuring fray and forged new relationships. On October 10, the PBOC and ECB established an historic bilateral currency swap agreement to purchase and repurchase yuan and euro from each other.131 It would be valid for three years and reach a maximum of RMB 350 billion provided to the ECB and €45 billion provided to the PBOC. The ECB considered the agreement a step forward in growing bilateral trade and investment between the EU and China, and a means of stabilizing markets.
By December 2013, the yuan overtook the euro as the second-most-used currency in international trade and finance after the dollar.132 In January 2012, it had been the fourth-most-used currency in global trade finance, and the euro was the second. The yuan represented an 8.66 percent share of letters of credit and collections in October 2013 compared with 6.64 percent for the euro. The US dollar represented an 81 percent share of letters of credit and collections in October, lower than in 2012, when it was 85 percent. During that period, the Japanese yen dropped one position, from the third-most-used currency to the fourth.
On the back of those developments, the yuan hit a twenty-year high. Investors concluded that Chinese policymakers were becoming more willing to adhere to market determinations.133 As a result, according to Zhou, the PBOC would “establish a managed floating exchange-rate system based upon market supply and demand” and “basically exit from normal foreign-exchange market intervention.” The moment had arrived to elevate the yuan to world reserve status.
YEAR OF THE HORSE
About three weeks before leaving office, Bernanke defended his epic QE program, claiming it had important effects on the economy. On January 16, 2014, in Washington, DC, he spoke at a forum sponsored by the Brookings Institution, the think tank that would become his employer.134 He saw no immediate sign of asset price bubbles, none that would hamper money-conjuring policy, anyway. He said, “We don’t think that financial stability concerns should at this point detract from the need for monetary policy accommodation which we are continuing to provide.”135
Meanwhile, in Beijing, Zhou’s read was different, as was his approach. The PBOC wasn’t exactly buying bonds G7-QE style to flood the banking system with cheap money to speculate in the financial markets. But it was increasing the money supply available to banks so they could keep China’s state-owned enterprises (SOEs) awash in conjured capital and to support massive infrastructure development projects that had reached overcapacity status.136
In China, conjured money went to building real things, whether they were needed or not, whereas for the rest of the G7, it tended to go into less tangible and more speculative uses. China was facing real economic concerns that had known effects in Brazil, Argentina, and Russia and that related to construction overcapacity internally. These were exacerbated by local currency devaluations from its major trading partner and rival, Japan. Since Japanese prime minister Shinzo Abe had been reelected on December 26, 2012, the yen had shed almost a fifth of its value relative to the US dollar, rendering the cost of its exports to the United States cheaper in dollar terms.137
As main trade rivals with Japan, both China and South Korea expressed concerns about that strong slide.138 On the other hand, the United States welcomed it. At a Council on Foreign Relations event on January 16, 2014, in another part of Washington, DC, Treasury secretary Jack Lew said about Japan, “They need to get their domestic economy growing.” He also warned, “Their long-term growth can’t be rooted in a strategy that ultimately turns in any way towards reliance on an unfair advantage because of the exchange rate.”139 The United States wanted to keep other currencies from devaluing, but its stance on Japan, a money-conjuring collaborator, was much more conciliatory than it was on China.
And indeed, now, the yuan was falling. On February 28, 2014, the yuan exhibited a record daily drop. Investors speculated that the PBOC would widen its trading band, allowing more volatility in currency trading, as the Chinese economy grew more sluggish.140 During February, the currency lost 1.3 percent of its value against the dollar, its biggest weekly drop since 2011.141
Zhou explained that those recent movements were simply the result of market influences. If anything, he argued, they demonstrated China gradually adapting its economy to this new, more liberalized framework. He emphasized, “We focus more on the medium-term trend, and the short-term trend doesn’t necessarily represent the medium-term one.”142
Meanwhile, Zhou assured an anxious world that China’s economy could sustain growth between 7 percent and 8 percent.143 But his external confidence didn’t show up in China’s currency. By March 20, the yuan fell to its lowest level in a year. That day, at her first news conference as head of the Fed, Janet Yellen said the Fed would probably end the quantitative easing program in the fall of 2014. That meant, technically, that the next step could be raising rates.144 Her comments pushed bonds and stocks, accustomed to an abundance of cheap money, down and lifted the dollar up (which had the knock-on effect of causing the yuan to drop further against the dollar).
Sure enough, two weeks later, on May 13, Lew criticized China’s devaluation path.145 It was the US Treasury Department against the PBOC, round one hundred. He admonished that if China wanted to make the renminbi a world currency one day, it needed to demonstrate this intention by letting the currency freely float according to mark
et movements. (Which it was.) The US government and the Fed could not conceive of their rate pronouncements and decisions as moving currencies as well, even though it takes two currencies to make an exchange rate.
CHINA AND RUSSIA
As a result of US hostility toward its policies and to diversify its economic footprint, China strengthened its ties with Russia. During key economic talks between the two nations on May 20, 2014, Russian president Vladimir Putin and Xi Jinping settled several critical trade and investment agreements.146 One was an agreement between VTB, Russia’s second-biggest bank, and Bank of China to pay each other in their domestic currencies. Russia’s Gazprom signed a thirty-year $400 billion deal to supply gas to China, with payments in Russian rubles and yuan.
The Chinese-Russian agreement represented a commitment to confronting the US dollar’s dominant position. According to Russian prime minister Dmitry Medvedev, the sanctions imposed by the European Union and the United States on Russia also incentivized the use of the ruble for trade and promoted its position as a future reserve currency.147
Business marched on ahead of politics. On July 9, the Wall Street Journal noted that American companies were conducting a record amount of business in yuan, looking to benefit from cost advantages over dollar transactions.148 Payments made by US companies in yuan had quadrupled in 2014 over the prior year, reaching a record of 2.6 percent of the global yuan total. Transactions denominated in yuan still represented a tiny portion of the annual $500 billion in US-China trade, but companies and banks in both countries saw the yuan playing a larger future role.149
During the annual US-China Economic dialogue that month, on July 9–10, 2014, US and Chinese leaders reached an implicit agreement that China would intervene less in the currency markets.150 The yuan had fallen 2.4 percent by then, as China’s economic growth fell to an eighteen-month low in the first quarter.
