China is letting the yuan crush the dollar — Trump is just one reason why

Key Points
  • The Chinese yuan has gained 10 percent against the dollar since the start of 2017.
  • Experts say Beijing is allowing the move so it will not appear to be manipulating its currency downward.
  • Against a trade-weighted basket of currencies, the Chinese yuan is still mostly stable.
A girl poses with a new 100 yuan note in Yangzhou, Jiangsu Province of China.
VCG | Getty Images

The has appreciated 10 percent against the dollar since the start of 2017, quelling some criticism that the export giant has been deliberately suppressing its currency to gain economic advantage over its trading partners.

This is all going according to China's plan, experts said.

Although the strength of the yuan against the dollar is in part due to the greenback's weakness, experts said the world's second-largest economy is also propping up its currency to appease President Donald Trump.

China has "reversed the rise" of the dollar against the yuan, and there's now "meaningful" strength against the greenback, Bilal Hafeez, global head of G-10 foreign-exchange strategy at Nomura, wrote in a recent note.

"Part of this was likely a response to the election of President Trump and the need to avoid being labelled a currency manipulator," Hafeez added.

On the 2016 campaign trail, Trump repeatedly said he would name China a currency manipulator from his first day in office. That has not happened.

Instead, the Chinese yuan rose almost 7 percent against the dollar in 2017, reversing three consecutive years of depreciation. In January, China's currency extended gains by another 3.5 percent.

At the same time, Beijing repeatedly stressed its desire to keep the currency stable — and it actually has managed to engineer this phenomenon against a basket of different currencies.

In 2017, the China Foreign Exchange Trade System RMB Index barely moved, starting the year at 94.83 and ending it at 94.85 — even though the yuan jumped against the dollar over the period. That measure is a trade-weighted index of the yuan, also known as the renminbi (RMB), as measured against a collection of currencies including the dollar, euro and Japanese yen.

"The Chinese authorities may be attempting to keep a range-bound [yuan] basket, which would mean ensuring euro (and yen) strength against [the yuan] to offset dollar weakness against [the yuan]," Nomura's Hafeez said in his note.

The CFETS RMB Index has gained about 1.3 percent so far this year. That comes even though the dollar is the heaviest weighted in the basket, and the greenback has lost over 2 percent against the yuan over the same period.

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Beijing is walking a tightrope

But, January's spike in the yuan against the dollar was "excessive by almost any yardstick," Cliff Tan, East Asian head of global markets research at Bank of Tokyo-Mitsubishi UFJ, told CNBC.

So, China will probably continue to manage its currency in the background even if it keeps its value against the dollar relatively high, analysts said.

Morgan Stanley analysts said in a note this week that the trade-weighted yuan should remain "largely stable" around current levels as Beijing's capital control efforts have worked.

"If [the yuan] continues to appreciate rapidly, policy-makers may seek to stem the rise in order to maintain stability in the trade-weighted [yuan], which would likely be achieved by verbal communication and a relaxation of some outbound capital restrictions," Morgan Stanley added.

Beijing is walking a tricky tightrope as the Communist regime seeks to balance political concerns with economic reforms and the demands that come with a market-based system.

In the second half of 2015, the Chinese government shocked markets by devaluing the yuan. That spurred capital flight due to concerns over the health of the world's second-largest economy — which further depressed the Chinese currency. Beijing has been trying to reverse that damage.

"I think they ultimately want a weaker currency, they just don't know how to achieve it. They tried in 2015, it didn't work, turned into a vicious cycle and they're kind of stuck right now with always trying to control everything but not knowing how to get a weaker currency through a structural slowdown in a way that does not cause a lot of disturbances to domestic financial markets for instance," said Jason Daw, head of emerging markets FX strategy at Societe Generale.

And then, there is the Trump factor should China be seen to deliberately adjust its currency downward.

"Trump has complicated their efforts on doing it. But, I think even without the Trump factor, 2015 is still too fresh in their minds as far as what happened and them not wanting that to happen again, and losing that control," added Daw at a recent briefing.