//More Money More Problems (follow up Ep3)

More Money More Problems (follow up Ep3)

So, I came across an article on Bloomberg today that added some more complications to the already shoddy funding problem for China’s “One Belt One Road” project. You can read the article here. For this blog post however, I want to focus on an underlying issue that China faces.

Within the article, author Christopher Balding notes how China could fill the funding gap by lending currency to other countries to fund their infrastructure projects. However, what currency do you lend in, and why does it matter? Well, it so happens that with China, the issue of currency denomination matters quite a bit. This is as China currently has tight controls of the flow of its currency, which government officials use to meticulously control the value of the Chinese Yuan relative to other world currencies. Their currency strategy typically involves undervaluing the Yuan, such that China can maintain a trading advantage relative to its global trading competitors. This strategy has not gone unnoticed however, and during the 2016 U.S presidential election even brought accusations of currency manipulation from then candidate Donald Trump. Therefore, if China were to lend in their own currency, they would be relinquishing the strict control of their currency, which opens up the Yuan to potential volatility and speculation. As Balding notes, this would “force officials to tolerate higher levels of offshore renminbi trading and international price-setting”.

However, lending in the Yuan will increase its prominence in global trade, which is one of China’s key aims. This has been shown by the progress they have made, especially when the Yuan was official labelled as a reserve currency by the International Monetary Fund last October. Yet, it is still far from being a widely traded currency, particularly when political risk is prevalent in the country, shown by how Yuan trade settlement only accounted for 11.5% of China’s total goods traded in December 2016, down from over 28% the year before.

The big dilemma for China is therefore: how to increase the prominence of the Yuan without relinquishing much control of the currency? But is this even possible? Can a currency whose value is heavily controlled by government policy be considered a global currency? Or from the other side, can a global currency be heavily controlled when by definition the concentration of the currency is decentralized? In light of this, it appears that something must give way, either China relinquishes capital controls and allows the Yuan to trade more freely (which is the likelier scenario), or China retreats and places more control when it cannot deal with the volatility that comes in the foreign exchange markets.

I guess this goes to show that you can’t have your cake and eat it too.