A strong dollar is crushing China's dream of turning the yuan into a global currency to replace the mighty dollar, raising an old question anew, whether Beijing will cash out from its U.S Treasury bond portfolio to support the yuan.
In the last five months, the greenback has gained roughly 10% against the yuan, crossing the psychological threshold of 7 yuan to the dollar due to a combination of monetary tightening in the U.S. and monetary loosening up in China. It's a policy mix favoring capital and product flows from China to the U.S.
In a sense, this should be a good thing for Beijing. It helps China export its way out of the ongoing slowdown due to lockdowns and the property bubble burst.
"A strong dollar is a double-edged sword for China," Joseph Trevisani, a senior analyst at FXStreet, a trading platform for currencies, told International Business Times in an email.
"While it raises the cost of most raw materials, makes corporate profit repatriation less remunerative and foreign loans more expensive, it also lowers the cost of China's products, a huge benefit for her export-driven economy."
The trouble is that the dollar has been rising against the currencies of other regional economies competing for exports to the U.S., like South Korea and Japan. Thus, the weakening of the Chinese currency has little impact on China's exports to the U.S., which are marginally higher these days than last April.
Meanwhile, Trevisani finds Beijing's concerns about a strong U.S. dollar self-serving, as in the past the Chinese authorities have intervened in the currency markets to push the yuan down against the dollar to cope with American tariffs on Chinese products.
"The best examples are from 2019 and 2020 when the USD/CNY touched 7.1780 and 7.1380 as Beijing tried to blunt the impact of the Trump administration's aggressive trade policy," Trevisani said.
Nonetheless, a weakening Chinese currency is a blow to Beijing's campaign to turn the yuan into a currency that would replace the dollar.
But there's a way for Beijing to turn its currency around: sell its Treasury holdings, which it has accumulated by recycling its trade surplus. As of July 2022, China held close to $1.235 trillion worth of Treasuries.
Still, experts are divided as to whether Beijing will begin emptying its chest of U.S. Treasuries to support the Yuan. Trevisani thinks this option is off the table as it would be counterproductive. "As the second largest holder of Washington's debt behind Japan, Treasury sales by Beijing would panic the financial markets," he said. "As a result, interest rates in the U.S. would jump, driving the dollar even higher."
Dr. Tenpao Lee, an economics professor at Niagara University, provided a mixed response. He thinks that Beijing may indeed use this option in the long-term, as it wants to internationalize its currency and play a critical role in the global economy. But this option may be off the table in the short-term, as its Treasuries holdings are worth more than its international trades.
Nonetheless, Lee sees China's large Treasury bond holdings as a constraint to the U.S. monetary policy.
"As a global currency, more than a half of the USD is circulated in the global economy," he told IBT in an email. "On the one hand, we prefer to have more international trades denominated in the USD. On the other hand, we need to limit the USD held by other countries to maintain our ability to make our monetary policies independently."