June 12, 2021

“The government watches its currency like milk on fire”

Losses and profits. Not enough babies, too much money, China has problems with the rich. Interventionism in addition. On Monday, May 31, it made two seemingly unrelated decisions, but which reflect the same concern: that of the future of its economy and its model. The country has finally opened the floodgates of the birth rate by authorizing families with three children, a decision accompanied by a set of social measures supposed to help large families and raise the retirement age. China has also, more discreetly, tried to slow the rise of its currency by raising the mandatory exchange reserve rate for banks. From 5% to 7%, this ratio increases the cost of holding foreign currencies (and particularly the dollar) for Chinese banks, which hold nearly 1,000 billion in their coffers.

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The idea is to reduce the pressure on your currency by making foreign currencies more expensive, and therefore by limiting the liquidity that allows you to use your dollars to buy yuan. A more sophisticated and discreet method than a pure devaluation (as in 2015), but also less effective. This is the first time in three years that the Middle Kingdom has used this stratagem, which reflects the government’s desire, still intact, to watch its currency like milk on fire. However, over the past year, it has appreciated by more than 11%.

Overheated

Analysts polled by the Bloomberg agency are cautious. This intervention will have only a very limited effect, they say. If the continued rise of the Chinese currency is not denied, it is not so much because of speculation as of the strength of the economic recovery. This results in a spectacular influx of capital. Despite rhetoric about the end of globalization, financiers from all over the world are flocking to China again.

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Beijing is now worried about this overheating of its currency, which nevertheless allows it to slightly reduce its raw material bill (iron and copper, in particular), which is in the process of soaring. What the country sees behind these movements are inflation risks that are becoming clearer. According to Financial Times, the increase in industrial production costs would have been 6.8% in April, even if for the moment this surge in prices has not been passed on to the end consumer. This is where the immediate concerns and those of the long term meet. Demography, by gradually reducing the workforce, carries the seeds of a major risk.