The USA and China are both strongly known around the world as two global powerhouses and so it isn’t a surprise to most that their currencies are so closely linked to the point of battling with one another.
With China’s consistently growing economy and the USA’s sheer power as a trade giant, everything from expenses and investments to job prospects can be affected by currency exchange fluctuations. As a result, the need for a stable currency link is a must, so why are these two countries locked in a battle as far as Forex is concerned? Can we really call it a battle? We’re exploring deeper below.
Why Are They So Strongly Linked?
To understand just why CNY and USD are so closely linked, we first have to understand the term ‘pegging’ in relation to Forex. This is essentially when a country maintains its own currency value at a fixed exchange rate to the USD, which of course leads to that currency fluctuating as and when the US Dollar does. You may have already guessed, but China’s CNY is pegged to the USD and, of course, this means that it is reliant on the strength of the USD – or at least, it has been up until recently.
China’s economy isn’t completely separate from the USD yet, however and given that the American currency is still the most widely adopted across the world in terms of foreign reserves, dropping it completely would arguably be a fool’s move. For now, China are building up their foreign exchange reserves through trade to the USA and with improvements in their own economy and a growth in investments from across the globe, America could soon see a new kind of pressure on their own currency.
So, What’s Going On?
Despite the fact that China’s Yuan is still technically pegged to the USD, the latter has seen increasing pressure as of late for a number of reasons, but China weren’t planning on following behind them. The aforementioned increase in investments has given the Yuan a strength in and of itself and especially against the dollar. The Yuan’s appreciation of 10 percent against the USD since the beginning of 2017 has brought up some criticism against China and their suppression of their currency but considering that the CNY is currently gaining strength against its American counterpart, it could very well have been a smart move on China’s part.
The debate as to whether China want a weaker currency is also a hot topic in the industry, especially after their attempt to devalue the currency in 2015 that they are still trying to recover from. However, they also want to be able to control their currency but this is proving to be difficult, especially with the fragility of Forex due to Trump’s election. Tensions are rising as far as trading is concerned and it’s a fine tightrope for any country currently pegged to the USD. Concerns in the US of a firmer Chinese currency could stem from China’s powerhouse status but the simple fact of the matter is that tensions are high and the economy could begin to suffer as a result.
What we do know, however, is that whether China’s currency remains high against the USD or begins to lower over the next few years, the current state of the market is seeing China’s Forex reserves rising as the US dollar weakens. As you can imagine, tensions are heightening as a result, but with China still recovering from their attempt at weakening the currency in 2015, they aren’t in a rush to try it again and so hopes that these reserves will become stable are rife across both the US and China. Of course, the battle is ongoing, as seen in Trump’s sudden announcement for 25% tariffs on more than 1,300 Chinese technologies, transport and medical related products and China’s resulting 25% tariffs on 128 U.S products including frozen pork, fruits and nuts and wine.
Nevertheless, China are continuing to focus on self-innovation, and have continued to invest in certain areas of the country by launching venture capital funds in numerous local regions as part of their high-tech company investment movement.
Europe’s Reaction
As you might expect, this growth in strength of the Yuan has led countries across Europe to react and switch out some of their USD foreign reserves for Yuan. The European Central Bank have announced that they’ve exchanged €500million for Yuan instead, and the French Central Bank have also admitted to owning some reserves in Yuan.
Much of this decision to change could be down to Trump’s ‘America first’ attitude and with the new approach to immigration and a generally changing attitude to anything ‘international’, many countries are looking for alternate investments – and China is filling that gap. However, there are still hurdles to be crossed as far as the Yuan becoming an international currency is concerned. A lack of regulatory transparency and the government’s intense control over their currency makes investors understandably reluctant to try their hand at Chinese assets, however with more relaxed rules and its growing strength against the USD, this could change in the near future.
Whether the CNY will continue to grow in strength has yet to be seen, but it appears that due to Trump’s ongoing actions, countries across the globe are growing reluctant to use and trade with the USD. As a result, the Yuan could prove to be the currency of choice given the size of the Chinese marketplace.