Renminbi to gain in 2025?
The broad consensus seems to assume that the renminbi is set to weaken on the back of expected tariffs. However, the widely shared narrative of an inevitable renminbi decline in the face of trade tensions might be missing the bigger picture.
While tariffs are often seen as damaging to exporters, as we mentioned last week in the context of a coming global slowdown, research by Amiti et al. (2019) suggests they can backfire on the imposing nation. Their study found that nearly 100% of the tariffs imposed on Chinese goods were passed on to US consumers, not absorbed by Chinese businesses.
Tariffs across the board could potentially strengthen the RMB as trade partners seek alternatives, a dynamic already evident in the soybean market where US tariffs led to China shifting its sourcing to Brazil, impacting US farmers and benefiting Brazilian producers.
Beyond the direct impact of tariffs, the RMB appears undervalued on several key metrics. China's trade surplus is on track for a record $930 billion this year, and it's predicted to exceed $1 trillion next year. The Big Mac Index, a light-hearted but telling measure of purchasing power parity, suggests the RMB is undervalued by roughly 38%. Part of the reason is substantially higher inflation in the US compared to China in recent years.
Adding another layer of weakness for the US dollar is the potential for faster than expected US interest rate cuts. With US national debt soaring, the Federal Reserve may be forced to lower interest rates to manage debt-servicing costs which already accounts for the third largest expenditure item, having recently surpassed US defence spending.
Academic studies have extensively examined the relationship between high debt-to-GDP ratios and economic growth. In their seminal work, "Growth in a Time of Debt," Rogoff and Carmen Reinhart analysed historical data spanning several centuries and numerous countries to investigate how public debt levels impact economic performance. Their research identified a critical threshold: when a country's debt surpasses 90% of its Gross Domestic Product (GDP), economic growth tends to decelerate significantly. The US is way beyond that threshold, with excessive budget deficits artificially boosting US growth, something that is not sustainable in the long term.
So, the future for the RMB might be brighter than many anticipate. While uncertainty always lingers in currency markets, the potential decline of the use of the US dollar in the event of an expanded global trade war leaves the floor open for the renminbi to fill the vacuum. Whilst the consensus narrative of an inevitable decline in the renminbi seems to be widespread, economics and political necessity to “Make America Great Again” suggests the opposite, with US dollar weakness and renminbi strength the most politically acceptable outcome for both sides.
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