On October 8, the PBoC published an essay – in both English and Chinese – defending China’s exchange rate policy and pushing back on foreign calls for the RMB to appreciate.
Just like MofCom’s July essay on overcapacity, the piece takes aim at the fundamental premise of Western policymakers’ complaints rather than answering them directly.
Beijing has now taken two key economic issues that advanced economies keep raising – the currency and overcapacity – and essentially said “suck it up, we’re not changing.”
The upshot: China is going to press this model until something breaks.
On this episode, Trivium China Podcast host Andrew Polk sits down with Dinny McMahon (Trivium’s Head of Markets Research) to unpack:
The PBoC’s three arguments defending its currency policy – from competitiveness to the lack of any agreed way to value a currency – and why Dinny thinks there’s some truth in each, while the essay as a whole “misses the wood for the trees”
Why capital controls complicate the case for a stronger RMB: with deposit rates thin and property and stocks sagging, how much money would leave if China let it?
The PBoC’s proposed fix: adjusting global imbalances by having deficit countries (read: the US) tighten their budgets while surplus countries like China boost consumption, and why Dinny calls this a pie-in-the-sky solution
Why Beijing’s playbook with Europe looks like buying time, trading small concessions for room to keep its model intact
Transcript
Andrew Polk: Hi, everybody, and welcome to the latest Trivium China Podcast, a proud member of the Sinica Podcast Network. I’m your host, Trivium Co-Founder, Andrew Polk, and today I am joined again- I think this is three in a row- by Dinny McMahon, Trivium’s Head of Markets Research. Dinny, let’s keep the streak going, baby. How are you doing, man?
Dinny McMahon: Yeah, too, right, mate? I was feeling unloved, but at least now I’m back in the rotation again. You haven’t forgotten me.
Andrew: Yeah, it’s good to have you back. Well, we just had a lull in the summer days, and then I had quite a few outside guests on. We’re going to keep mixing those people in, but it’s good to have you back in the rotation. While I’m having you on today, we’re going to do another quick reaction podcast because, last week, the PBOC published an essay in both English and Chinese, defending China’s exchange rate policy and sort of pushing back on foreign calls for the renminbi to appreciate. We’re going to talk through that essay — what it argues, whether the arguments hold up, and kind of what it tells us about Beijing’s thinking, not only about the renminbi, but also about the trade surplus and the growing sort of geopolitical tensions around that.
We will do some quick housekeeping since this is one of our shorter pods. Just a quick reminder, Trivium is a strategic advisory firm that helps businesses and investors navigate the China policy landscape. So, if you need any help on any of the issues that we’re talking about today or any policy issue related to China, please reach out to us at hq@triviumchina.com. All right, Dinny, are you ready to get into it?
Dinny: Yep, let’s roll.
Andrew: All right. So October 8th, just late last week, I think Thursday, the PBOC, that’s the central bank, published this essay, again, both English and Chinese, which is definitely notable. Anytime China publishes something in English, it’s like — hello, foreigners, we would like for you to pay attention to this issue. The essay was blandly titled, “The PBOC’s Views on the RMB Exchange Rate.” But that sort of belied some more- not bombshell findings, but a little bit more sexy content than the name would imply.
Anyway, it was a defense of China’s currency policy and an attack on those foreigners calling for RMB appreciation as a way to wind back China’s trade surplus, which is something especially the Europeans have been calling for in their trade negotiations with China recently. And this, interestingly, is not the first time we’ve seen a big piece like this. At the end of July, the Ministry of Commerce also published a similar essay on overcapacity, explaining why calls for China to rein in its overcapacity were totally without merit. So, seems like this may be the start of a growing trend. Dinny, why don’t you walk us through the argument that the PBOC makes in this paper so we can kind of understand what’s going on here?
Dinny: Yeah, right. So it kind of comes down to three key arguments. The first is that the PBOC is saying, look, China’s export strength is the result of its global competitiveness, not its undervalued currency. So, all the innovation, all the industrial upgrading it’s been going through over the last few years- that’s why China’s got this massive trade surplus. It’s got nothing to do with the currency. That’s the first point. The second is they’re arguing, look, exchange rates aren’t determined purely by the trade balances. So, to foreigners who are saying, “Hey, there’s this massive trade surplus; it’s indicative that the value of the renminbi is way off.” PBOC is saying, “Look, the value of a currency isn’t purely determined by the trade balance. It’s also influenced by factors like economic growth, monetary policy, geopolitics, random economic shocks.”
And so you can’t point to any one thing and go, “Aha! The currency is undervalued.” And then the third point is that you know there is no one standard globally accepted method for coming up with what an appropriate value of a currency is. So, there’s a bunch of different methods. They don’t always come up with the same answer. So, there’s no point pointing and saying, “Hey, according to these calculations, the renminbi should be 20% higher,” because the PBOC is saying, “Yeah, but which method is right?” There is no way of kind of coming up with answers.
So, that’s sort of a summary of what the essay was getting at. As you said, no bombshells here, but it’s kind of putting everything together as a coherent rebuttal to those arguments that the answer for the rest of the world to China’s trade surplus is the currency.
Andrew: Yeah, I think that last point is particularly notable in my mind about the PBOC arguing that there’s no real well-established methodology for evaluating a currency’s appropriate level. Well, first of all, I think the rebuttal among the IMF and Western economists, and the EU would be that, well, actually there’s a bunch of different methodologies and they all say that China’s currency is undervalued by X%, call it 12% to 25% or whatever. But they all agree directionally. They might not agree exactly on the proportionality.
But the reason I bring this up is this was also a key argument in that MOFCOM paper on overcapacity, which was overcapacity doesn’t have a globally recognized definition. And in fact, we would argue that overcapacity is not even really a thing. So, sort of the old, I take issue with the premise of your complaint, or the premise of your question is sort of what they’re going with, it seems like here. Does that sound right?
Dinny: Yeah, absolutely. They’re taking on the topic for debate, you know, the actual parameters for debate. So yeah, no, I think you’re spot on.
Andrew: Well, I mean, it just reminds me, I don’t know if they’re doing themselves any favor because this is like what your most annoying friend does when you argue with them, right? It’s like, well, you know, it’s like, “I’m not going to answer your question. And in fact, I’m going to attack the very premise of your question.”
Dinny: Do you have anyone in mind?
Andrew: They know who they are. I’ll just leave it at that. All right. Well, so, obviously my feelings on the matter are somewhat out there, but would you, broadly speaking, say that these arguments have merit going through each of them?
Dinny: Yeah, on some level. I mean, there’s no denying that Chinese firms have become incredibly competitive globally. They’re selling incredibly well-designed, cheap, high-quality electric vehicles, batteries are cutting-edge. Across a host of technologies, yeah, Chinese firms have become globally competitive. The other argument that the exchange rate isn’t determined purely by the balance of trade; yeah, I mean, that’s a fair argument. You kind of look at if China didn’t have capital controls in place, then the value of the currency wouldn’t necessarily appreciate. In fact, sure, you’ve got a trillion dollars coming into the economy every year from the trade surplus.
But if you got rid of capital controls, just how much money would like gush out of the country? I mean, anybody with any savings in China at the moment, given a choice, would move their money overseas. Bond yields keep falling. Interest rates on deposits, bank deposits, are wafer-thin. The property prices are still falling. The stock market is declining or moving sideways pretty much if you’re investing in anything other than AI. I mean, if you’ve got money in China and you’re looking overseas and you’re looking at rising U.S. bond yields and you’re looking at U.S. stock markets, just looking around the world, everywhere else, you’re going to get a better yield on your money anywhere else in the world at the moment if you’re a household saver in China.
So, there’s that question of, like, yeah, sure, you’ve got all this money coming in through the trade surplus. But if you didn’t have these barriers in place, just how much money would be leaving the country? And that’s what the PBOC was getting at. Hey, it’s not just trade surpluses that determine it; it’s also monetary policy, and interest rates are pretty cool.
Andrew: Yeah, I’m laughing because that’s a funny argument for the PBOC to make, which is, well, you know, if we didn’t have these capital controls, then a bunch of money would leave the country, so maybe the currency is actually overvalued.
Dinny: I’m reading between the lines here. They’re not exactly going into detail on this particular point. But anyway, look, that’s kind of where it’s coming from. It’s got these list of three arguments, and there’s a certain amount of truth to all of them, but it kind of misses the wood for the trees a bit.
Andrew: Yeah. Fair enough. Well, it’s exactly, again, like the MOFCOM paper on overcapacity where there’s an element of truth to everything they argue, but very clearly pretty heavy spin on the ball in terms of them trying to justify their approach. But can you tie this to the trade surplus for us specifically? Because that’s obviously what everybody cares about. I mean, no one really cares fundamentally what the currency is or what the currency price is. They only care about it insofar as it distorts trade practices. So, how does the paper reflect the PBOC’s thoughts on the trade surplus?
Dinny: So, it has a solution. And we’ve heard this in other places before. I think that we may have even seen a version of this in the MOFCOM essay on overcapacity. It frames the issue not about being its own trade surplus, but it frames the problem as being about global imbalances of which China’s trade surplus is perhaps part of it. And so, when it comes to imbalances, it’s not just that China exports so much, but the other side is that the U.S. in particular borrows too much. And so, PBOC’s solution to global imbalances writ large is that deficit countries, and we’re talking about the U.S., but it doesn’t call out the US by name, but that deficit countries should consolidate their fiscal positions, raise the domestic savings rate, and strengthen industrial competitiveness, while surplus countries, China, should boost consumption and investment.
And what that really means is that China is saying, “Hey, the U.S. should balance its budget.” But of course, I mean, that would be kind of recessionary almost by definition. The other side of the equation would be that China would boost domestic demand. So, kind of in a perfect world, China would create global demand by sort of expanding household spending or whatever, just as the U.S. demand was shrinking. And that would ideally help offset those sort of recessionary forces in the U.S. because it could export to China and everything would be wonderful.
And I mean, it doesn’t sort of lay all this out in great detail, but this is sort of the implications. And of course, that’s a wonderful idea, but it’s absolute pie-in-the-sky sort of stuff because China has proven itself incapable of boosting domestic demand, right? I mean, this is not something it needs to do in concert with the rest of the world. There doesn’t need to be a global pact for everyone to agree, “Well, we’ll rebalance on our side if China rebalance is on your side.” China’s been trying to boost domestic demand since it came out the back end of COVID and has been absolutely unable to do it for a bunch of reasons that we’ve talked about on the podcast.
So, the way out, and, of course, of the U.S. side as well, to think that the U.S. can kind of rein in its deficit, I mean, the only thing the two parties seem to have in common at the moment is they’re both willing to borrow more and more. So, I mean, the idea that this is feasible at any sort of point in time, it’s completely unreasonable to think that this is the solution to anything. And that ultimately is why the currency is so important, because in the past, it’s been the tool that rebalances trade when domestic political considerations preclude making hard decisions, right?
So, in some ways, it’s ideally an automatic stabilizer. And of course, it never really works that way without political agreement. So, you kind of need things like the Plaza Accord. But that is why people are talking about it, because there is a potential for currency to rebalance things when, domestically, politicians and governments can’t make those readjustment decisions.
Andrew: Yeah, I agree with you that China can raise its consumption rate without global coordination and global rebalancing. I will say this is one where I have a little bit of kind of sympathy for the Chinese argument, which is, at least from the U.S. side, we never seem to sort of look at our own domestic imbalances or domestic economy, which is U.S. savings rate could rise substantially, right? Which is the opposite of China’s overly high savings rate, which a lot of people would say is the fundamental issue of weak consumption and overinvestment and, therefore, the large trade surplus.
And some kind of coordination on that actually might make a little bit of sense. But I do feel like when people talk about this conversation from the U.S. side, it’s just China needs to do this, China needs to do this, China needs to do this. It’s kind of like, my view is if you’re sitting at a table and somebody keeps bringing you food and you keep eating it, getting mad at them for your gluttony. So, at some point you can just stop eating it, which I guess is sort of what the tariffs are about. But anyway, I think a little bit more self-reflection from deficit countries might be worthwhile. Anyway, I’ll get off my soapbox. But where does all that sort of leave us in terms of your main takeaways from this essay?
Dinny: Yeah, well, I think that the PBOC and the MOFCOM essays, they’re similar in that Beijing is taking two issues that advanced economies have complained about and pretty much said, “Suck it up, we’re not changing.” So that, I think, in some way, is the real significance of the PBOC essay. It’s not that it’s sort of a standalone rebuttal to calls to appreciate the renminbi. It is part of a broader trend where Beijing is kind of sticking its heels in. And of course, the problem with this is that Beijing, I think, sees discussion of overcapacity and currency revaluation as an attack on China. And I guess to a certain extent, there is probably an element of that.
But I think there is also perhaps a good faith element from outside of China, whether it be the U.S., or the EU, where foreign capitals are trying to look for an issue that they can negotiate over. Because the big issue here is the trade surplus. What they’re trying to do is kind of come up with some sort of common ground whereby we can end up in a more sort of balanced trade sort of environment. And so, Brussels, D.C., they’re looking for an issue that they can negotiate over. And I think it’s interesting with the overcapacity issue because the EU only started talking about it, only raised it after Beijing started talking about it.
I think it was what, December 2023, at the Central Economic Work Conference? Beijing started talking about overcapacity as being a potential threat to the industry over the next 12 months. We hadn’t seen this in years. Within a month or two, the EU was like, “Hey, overcapacity, this is something that we really need to deal with.” And so, it was kind of the EU trying to find common ground with Beijing, something they could kind of discuss. And then, of course, Beijing stopped, for that exact reason, stopped using the word overcapacity and started using involution.
And so, I think part of the issue here is, part of the problem is that Beijing is like, we’re not going to countenance currency revaluation. Overcapacity isn’t even an issue to be discussed. But the other side of the equation is that the EU, in particular, is kind of looking for common ground. And every time it raises an issue, it gets absolutely shut down. And we’re kind of getting to a point where this trade surplus with the EU, the EU seeing its industry being potentially hollowed out, I mean, things are starting to get existential. So, the question is, I mean, if Beijing is just going to go, “Nah, we’re not going to engage on sort of every complaint,” well, it kind of suggests that we’re heading in one direction.
It means there is no holistic solution. And it means relations are just going to keep deteriorating until something breaks. And I’m not quite sure. I don’t think any of us really know what that sort of looks like, but it’s potentially something very, very different from the global trade order we have at the moment.
Andrew: Yeah, I tend to agree with you. I just want to unpack a couple of things. One is kind of this idea that China is saying it is what it is. The model is the model. Deal with it. I totally agree with that’s increasingly the message, both from this paper and the MOFCOM paper, and from the messaging I was hearing back in March around the China Development Forum. This is kind of what people, especially European officials, had been telling me that they were kind of hearing from the Chinese side.
I also think it’s really interesting that, in both of these essays, China points to, so we already talked about that we’re going to take issue with the premise of your complaint, but they also point to innovation as China’s key sort of development or key competitive edge that is driving the surplus. They’re saying, like, “You’re just upset because your citizens are buying our goods because they’re so much better. And your companies are buying our B2B products because our company, our manufacturing companies are so much better.”
And so, this is just an outcome of China’s innovation ecosystem. And I think that them making that argument, first of all, falls on deaf ears. But I think this is also one where there’s been on the ball, but also they probably believe it. I think in part, that’s a good faith argument. And they just feel, I guess, this is another piece, maybe just kind of understanding the Chinese policymaker mentality is they feel all of these arguments, I think, are really just kind of specious arguments that the West makes up to contain China, right?
Oh, you’ve got overcapacity. Oh, your currency, whatever it is, whatever the reason for the trade surplus is, it’s not because your companies are good and you have innovation and everyone wants to buy your products, it’s because of all these other things. These are things you’re cheating on or distorting the market. And Chinese officials feel attacked by that. Again, I think it’s part disingenuous, part genuinely believing in their own innovation, and part genuinely feeling attacked. And the reason I bring all that up is because I think it goes back to what you just ended on, which is it’s very hard to see common ground for negotiation under those circumstances.
I actually was really surprised, as we’re talking here on Monday, October 12th, the EU-China negotiations over the weekend seemed to have actually produced positive momentum in terms of they seem to have this agreement on China being willing to produce sales of hybrid vehicles from China into Europe. But I think, ultimately, my view is China is dug in. And even with this positive sort of cyclical turn in the negotiations, the structural part of the negotiations is China digging in, and this kind of coming to a head.
And I actually wonder if it’s kind of the Europeans taking this small concession from China and being satisfied, and China sort of hoping that that diffuses what was clearly building European frustration, and China’s just going to go back to what it was doing structurally. And then six months from now, Europeans will be up in arms and negotiating and a line in the sand again. Anyway, I’m just rambling a little bit, but trying to tie all these together from my perspective. Any thoughts on any of that?
Dinny: Yeah, mate, I don’t think you’re rambling at all. I think that’s exactly what China is doing. I think the Chinese have worked out how to engage with Europe. And I mean, one of the great complexities of Europe is that it is not a single nation. And trying to cobble together a single trade policy, a single policy on anything with so many disparate countries is incredibly difficult.
And so, I think China makes a concession now, it’ll make some parties in Europe relatively happy for a while. Others will still be upset, but it’ll buy it time. China’s played this game before. Ultimately, all it needs is time. If you kind of look at the solar sector, solar manufacturers in the United States, it’s hard to believe, but the United States once had solar manufacturers. And they took China to the WTO, and they asked for support from the U.S. government. And eventually, it got those things. And it eventually won cases, I think, in the WTO.
This isn’t really my area, but my understanding is that the remedies came so late that by the time they came through, those manufacturers had already lost so much market share and they’d already lost. And Chinese firms were in a dominant position, and there was no real way to kind of claw back the market. And so, I think China kind of knows it can play a similar game with Europe. It offers some concessions now, and then the problem gets worse in other areas, it gets worse in new areas, and it takes time and effort to kind of build up the consensus within Europe to go after the next thing.
That’s not to say that Europeans might not pivot. They might change their approach. They might get a broader consensus in place that allows them to take a harder line. I mean, all these things can happen, but I assume that what the Chinese are doing is just what I outlined.
Andrew: Yeah. Well, we will continue to follow this stuff. I guess we should wrap up here, but just one final comment from me is that the most unsurprising thing about this PBOC document is just that, on the exchange rate, is that the PBOC is not going to unilaterally re-evaluate the currency. Basically, since the early ‘90s, they’ve thought that Japan revaluing through the Plaza Accords was one of the number one things that led to the Japanese economy tanking and the Japanese bubble bursting.
And everyone knows the parallels between China and Japan, and it’s just not going to happen. They’re not going to take that, what they see as a risk. It’s not even a risk in their mind. It would almost certainly lead to a reduction in economic activity, a negative impact on asset prices, huge fallout in the trading regime. It’s just not going to happen from their side. You agree with that? Then we can wrap up.
Dinny: Absolutely. Yeah, no question at all.
Andrew: Yeah. All right. Well, we’ll leave it there. Thanks for this, Dinny. Really great to dive into this stuff with you, and I appreciate the time.
Dinny: No worries, mate. Pleasure as always.
Andrew: Thanks, everybody, for listening. Bye, everybody.
