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Powell’s Dollar, China’s Problem – WSJ

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Remember the dollar?

Jerome Powell

and his colleagues at the Federal Reserve generally prefer to forget about it, but other countries don’t have that luxury. Witness the growing problems created by a strengthening Chinese yuan—or, rather, a weakening dollar.

The yuan this week hit a three-year high versus the dollar, at around 6.38. This caps a year of steady yuan appreciation and is prompting Beijing to act to manage the exchange rate before China’s currency strengthens further.

Regulators on Monday said banks will have to hold more reserves against their foreign-currency deposits, a measure intended to prop up the dollar by mopping up dollar liquidity within China’s financial system. Chinese depositors now hold more than $1 trillion in dollars, often the proceeds from booming exports, and authorities seem to worry a sudden mass move to convert those deposits into yuan could send the exchange rate skyrocketing.

Some yuan strength is explained by developments in the Chinese economy. Exports have rebounded since the depth of the pandemic. Greater openness to foreign investment into stock and bond markets last year propped up the currency. Beijing this year has tried to rein in credit growth to manage risks in the financial system, sustaining higher interest rates relative to the U.S.

Yet this is more a dollar phenomenon rather than a yuan event. The yuan is appreciating versus the dollar, while its exchange rate with the euro has been mostly stable in recent months. This is consistent with the broader decline in the Wall Street Journal’s dollar index since the pandemic began.

It’s a natural consequence of Washington’s unprecedented spending blowouts in the past year, with more on the way. Mr. Powell effectively is monetizing $960 billion of federal debt each year via $80 billion of monthly Treasury purchases to suppress rates. You’ll look in vain for evidence that anyone at the Fed is considering what this means for the dollar, or what this dollar depreciation means for America’s trade and trading partners.

Here’s what it means for China: Some yuan appreciation versus the dollar might help China contain a looming inflation problem, as it experiences the same rising commodity prices and supply-chain bottlenecks afflicting everyone else. There is also evidence heavily indebted Chinese companies have grabbed the opportunity to pay down dollar-denominated debts, too.

Those benefits come with risks. If a stronger currency leads to smaller yuan-denominated revenues for exporters, that could exacerbate the financial fragility of an economy in which public and private debt exceeds 300% of GDP. Beijing also worries that too rapid an appreciation could spark destabilizing capital inflows or outflows (the nature of China’s quasi-market economy makes it hard to predict which). Managing the fallout from the Fed’s weak-dollar policy could also expose China to trade retaliation from Washington.

Many of these dangers are Beijing’s fault, stemming from its credit-fueled policy mistakes over many years. But the U.S. has no interest in adding exchange-rate worries to the list of global economic problems.

The eurozone, United Kingdom and others are starting discussions about whether and when to exit from their pandemic monetary and fiscal policies. Washington’s refusal to do the same will open new gaps between the U.S. and other major economies, with unpredictable consequences that could start, but might not end, in currency markets.

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Appeared in the June 4, 2021, print edition.

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