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China is at it again! FX policy change mulled by bank as Yuan rockets against Dollar

22 May 2021

The People's Bank of China (PBoC) is unlike any other central bank among economically dominant nations. It is an all-encompassing, communist government-controlled entity which dictates every aspect of fiscal life within the heavily censored domestic market and its strictly monitored economy, which is arguably the most powerful in the world.

Planned economies such as that operated by the Chinese Communist Party are largely defunct these days. Human nature does not have many compatible facets with the Leninist ideology that has shaped modern day China. In almost every other nation in the world that has attempted to operate it, it has failed and given way to a free-market replacement which has had to struggle with the chaos wreaked by the demise of totalitarian state control.

Not in China, though. China absolutely flourishes under this particular system and competes - or perhaps leads - against the very top tier nations with capitalist-style free market economies. For this reason, China's FX policy is of great interest to participants in the global financial markets.

The Yuan, China's national currency, may well be under strict capital controls and cannot ever be considered a major due to its origin as the legal tender of a totalitarian government-run, state-controlled society, but it is vital to the value of almost every asset class in every global market.

Today, one of the many officials at the PBoX has proposed that the Chinese government should allow the Yuan to rise in value to offset the rising costs of importing commodities which represents a change in method from the PBoC.

This notion has caused some degree of contemplation among Tier 1 interbank FX dealers in Western markets who consider it a new direction, as described this morning in mainstream media by analysts at ING Bank. "Regarding the PBoC comment to let the yuan rise to offset higher commodity import prices, it is possible for the PBoC to let the yuan move by itself in reaction to those PBoC comments. The market could push the yuan higher against the dollar, in effect, the market will be fulfilling the PBoC’s desire for a stronger yuan" said one analyst.

The consensus is that it could be hard for the USDCNY to reach 6.10 and ING Bank's official forecast is 6.30 by the end of 2021, however it is a consideration that a strong Yuan may damage exporters and producers in the same way that high commodity prices does.

This is rather an odd consensus bearing in mind that today, the Chinese Yuan rose to 6.41 against the US Dollar, which is way higher than anticipated by these analysts and outstrips ING's year-end prediction. A few years ago, the Chinese government attempted a PR campaign to influence the nations which are home to major currencies that its Yuan could become a major currency alongside the USD, Euro and GBP.

I personally made my own standing very clear on that point at the time, in that it will never happen. What did happen, however, is that it became a reserve currency which is rather unbelievable considering its communist 'People's Bank' issuance.

Back in 2015, the International Monetary Fund formally accepted the Chinese yuan renminbi into the Special Drawing Rights (SDR) basket of reserve currencies. That decision, following an alignment with the IMF’s requirements by Chinese officials, marked the opening of a potential for a monumental shift in the entire structure of the forex industry, from the interbank sector which will now be able to conduct legitimate conversions between major banking institutions across the world, and on the retail side the chance to include the yuan as a major on trading platforms.

What ensued was actually the opposite. China imposed strict restrictions on commercial FX settlement in Yuan and then just one year later removed all overseas FX brokerages from its shores unless they had a fully Chinese-owned subsidiary which only did business in China as a Chinese company with no directors or capital flows from overseas.

Therefore, whilst the Yuan is a reserve currency and remains so today, its place on the global stage will never be alongside majors, yet it manages to influence their price because of the might that China has as a unitary and dominant economic powerhouse.

Because of the closed nature of Chinese business, the government’s non-recognition of foreign entities, lack of recourse, and internet restrictions, combined with the general preference for managed portfolios or automated trading via EAs among Chinese investors, these credentials are of infinitely greater importance than whether the local currency is exchangeable worldwide without restriction. Bearing all of this in mind, a rise to 6.41 against the US Dollar, contrary to predictions, is perhaps not so unbelievable after all. In fact, it's a reality.

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