China is being pressured to halt its interventions to prop up the US dollar in world currency markets, with opponents emphasizing how much harm the policy is causing to other countries. But China’s authorities might respond more favorably to an argument that points out how China’s own economic health might benefit from abandoning the current exchange-rate policy, which pegs the yuan to the dollar.
Such an argument is not difficult to make. China is currently pursuing a contradictory set of policies that paradoxically undermines its own economy while propping up America’s by accommodating pump-priming by the Federal Reserve. China and Hong Kong are the largest net purchasers of US Treasury securities. Otherwise, Treasury bond yields would be far higher, thwarting monetary expansion by the Fed.
Back in China, the dollar peg has led to large and growing foreign-exchange reserves, which are fueling domestic inflationary pressures and causing public-sector debt to balloon. This is because official capital controls oblige exporters to deposit hard currencies with the People’s Bank of China in exchange for freshly printed yuan (usually as bank deposits) or government debt. Both arrangements will eventually become untenable, because they will generate either an intolerable rate of inflation or an unsustainable burden of public-sector debt.
These are high prices for China to pay to maintain its current policies, including the pegged exchange rate. There is a great deal of volatility in foreign-exchange markets across the globe, mainly owing to the weakening of the dollar. As such, China and other countries are holding a depreciating asset that should be managed to serve domestic interests rather than those of the US.