Is China’s surging currency a fake signal?

Although it has been a little wobbly over the past few weeks, the performance of the US dollar this year has been extraordinary. It has strengthened against just about every currency of consequence even though inflation pressures in the US have been worse than expected and the Federal Reserve has done nothing to counter them. Also remarkable is that the dollar has gained against currencies that would in past times have been supported by buoyant commodities prices, as well as against currencies where central banks have raised interest rates.
Of the very few currencies that have been stronger than the dollar, China’s renminbi has put in the most dramatic performance. Most analysts say the renminbi’s strength has to do with huge demand for Chinese products, driving the country’s trade surplus higher, and for its government debt, which yields a lot more than government bonds in the developed world. That would be a more convincing argument had the currencies of countries with similarly strong net trade balances, such as Russia or Australia, been strong too. To my eyes, the renminbi’s strength speaks volumes about just how the bad country’s woes are — and how they are like Japan’s three decades ago.
The first reason why it makes sense to view China’s troubles through a Japanese lens is that Japan’s currency also soared when the game was up. Even though the stock and property markets were in meltdown and the economy was dipping in and out of recession, the yen reached an all-time high of 79.75 per dollar in April 1995. That marked a 50% increase in trade-weighted terms from the beginning of 1990. To say the yen’s performance caught everyone by surprise is something of an understatement. The renminbi has also started to climb sharply, especially against the euro and yen. The trade-weighted renminbi has risen about 8.5% since the end of last year.
All of which is interesting, but hardly conclusive. That is why you need to grasp the economic reasons underlying the renminbi’s climb. So, put a towel around your head and read this and the following paragraph closely. A simple way of thinking about what happened in Japan and what is happening in China is through the prism of an economy’s sectoral balances. In a very simple model, there are three sectors to think about: the private savings balance, the government savings balance and the overall current account, which measures saving for the economy as a whole. All of these must by definition sum to zero. If a country runs a current-account deficit (meaning it spends more than it saves) then together, by definition, the domestic sectors must together run an equivalent surplus.
China, though, runs a current-account surplus (it saves more than it spends). The surplus shrank until the end of 2018 but has since started to grow rapidly. This means, again by definition, that when combined, the private sector and the government must be running a large and growing deficit. The recent increased corporate dis-saving, financed by huge borrowing, only added to what had anyway been a spectacular borrowing binge.
The problem now is that this corporate borrowing spree has been slammed into reverse. Its companies are having to save more than they earn. Excluding that portion of lending that is simply adding unpaid interest to the principal, credit growth in China has not been this weak since the mid-1990s.
Real money growth has not only collapsed, it is probably negative. Small wonder that domestic demand has shriveled. That is why the government has very slightly loosened monetary policy: reserve requirements for banks were relaxed again last week. That is also partly why the country’s trade surplus has ballooned: it is being driven higher as much by falling domestic demand as by robust overseas demand.
The renminbi is far from a free-floating currency, as government policy has often dictated its direction. And at the very least the government would like a stable renminbi whilst companies pay off their huge overseas debts.

—Bloomberg