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It took currency traders a decade to get over China's 2015 devaluation stunt.
In a turbulent August for Asia's largest economy, President Xi Jinping's team announced a nearly 3% devaluation of the yuan against the dollar. Naturally, it caused chaos — at least briefly — in world markets. The real impact, however, has been felt by China itself, as massive amounts of capital flee yuan-denominated assets.
Will we see Xi Jinping's team adopt the same tactics again as it did in the trade war threatened by Donald Trump?
Only Xi Jinping, Premier Li Qiang and People's Bank of China Governor Pan Gongsheng can answer this question. With less than two weeks before President Trump 2.0 takes office, the Communist Party led by Xi Jinping is adopting a “don't test the United States” attitude towards those who are shorting the yuan.
This week, it is working hard to ensure that the People's Bank of China's daily reference rate is anchored above a psychologically important level of 7.2 per dollar.
There are very good economic reasons for staying the course. A weaker yuan could make it harder for troubled property developers to make payments on offshore bonds, increasing the risk of defaults. RMB internationalization is arguably the most important financial reform in the Xi Jinping era. Currency manipulation could squander this progress.
What's more, a weakening yuan could haunt Trump's incoming White House in unpredictable ways. If Xi Jinping is worried about Trump's threat to impose 60% tariffs on Chinese goods when the yuan is trading at 7.3, how will Trump World react if the yuan falls to 7.5 or 7.6 to the dollar?
While there are reasons not to devalue the yuan, Beijing has an excellent reason to do so: falling consumer prices. Analysts at Gavekal Research aren't the only ones worried that China “is facing the precipice of a lost decade of deflation,” unlike Japan which is still trying to escape.
True, prices in China have not plummeted. But seeing prices fall for six consecutive quarters in the world's second-largest economy is anything but optimistic. After all, China is now facing its worst deflation since the Asian financial crisis of 1997-1998.
Notably, this is another moment when global markets worry about a devaluation of the yuan on an almost daily basis.
At the time, markets around the world were grappling with the impact of currency devaluations in Thailand, Indonesia and South Korea. Investors in New York and London feared more shocks from Malaysia, where then-Prime Minister Mahathir Mohamad launched a war of words against George Soros. Mahathir called Soros an “idiot” while accusing the hedge fund billionaire of trying to devalue the ringgit in the same way he devalued the pound in 1992.
But at the time, China was the biggest concern. Markets feared that Beijing's decision to allow the yuan's exchange rate to fall in the late 1990s would trigger a new round of competitive devaluation.
Thankfully, China has resisted this urge. When Beijing did pull the trigger on devaluation in 2015, the foundations of the global system were on firmer ground. But during that time, Soros wasn't so sure. In January 2016, Soros warned that a “hard landing” in China was virtually inevitable. Beijing accuses Soros of “declaring war” on the yuan.
Fast forward to today, and you have to wonder whether Soros was ultimately right about the yuan. Unlike in 2015 and early 2016, if Xi Jinping decides to shake up currency markets again, all bets may be off.
If the world has learned anything from Japan, it's that deflation requires swift and overwhelming action. Sadly, Xi Jinping’s team has been rather lukewarm when it comes to fixing the ailing real estate sector. Progress has been slow to stabilize local government balance sheets, address near-record youth unemployment or build a stronger safety net to encourage households to save less and spend more.
The price paid by Xi Jinping’s China is deflation. Many economists believe that the best way to resolve this dilemma is to devalue the yuan.
The timing, however, complicates China’s beggar-thy-neighbor approach. This will conflict with the global economic plan of the Trump 2.0 White House. The best-case scenario for Trump’s “tariff man” behavior is that it’s all a bluff designed to bring China to the negotiating table. Still, it’s hard to imagine the notoriously undisciplined Trump resisting the urge to push back against Xi Jinping’s currency disobedience.
Another: The Trump 2.0 team, which took office on January 20, has been hinting at its currency strategy. In the Trump 1.0 era, some people talked about gaining trade advantages with China through the depreciation of the US dollar. Cooler heads prevailed. But who is the adult in the room this time? Maybe it’s Scott Bessent, Trump’s pick for Treasury secretary. But the bullishness on the dollar could be higher than Bessant's salary.
Interestingly, anything in 2025 is likely to scare global markets more than Trump’s tariffs. However, a currency surprise from China could be the rare disruptor capable of defeating Trump.
