The multi-trillion dollar question: Should RMB appreciate? - Baiguan Radio #36

Welcome to a new episode of Baiguan Radio. Today, we welcome Johnny Zou of East8’s Newsletter again to talk about the very important question of the RMB exchange rate.

The Argument for RMB Appreciation (00:00:16)

The prevailing view is that the RMB is undervalued. This argument is primarily based on the trade and goods sector. Evidence includes the decline in China’s price levels relative to its trading partners since 2019, despite productivity growth. Appreciation is seen as a tool to boost domestic consumption and reduce international trade disputes. (For instance, as championed by Mr. Shan Weijian here)

The Counter-Argument: Why Appreciation is Risky

Johnny presents two primary reasons for his skepticism that the RMB should appreciate right now:

1. The Financial Flows Test (00:03:47)

If the RMB were allowed to free float and the capital account were opened, the currency would likely depreciate. This is because a large amount of Chinese onshore money is currently “trapped” and would flow out to invest in foreign assets. This underlying psychological reality of Chinese households—selling houses and moving money overseas—is the reason a true free float will likely never happen.

2. The Financial Assets Angle (00:04:46)

The argument for undervaluation is incomplete because it ignores the financial assets side of the economy.

* Real Estate Dominance: Chinese household wealth is overwhelmingly tied up in real estate, which accounts for up to 59.1% of residents’ assets.

* Overvaluation: Compared to the income of Chinese residents, real estate is still hugely overvalued.

* The PBOC’s Balance: The current stable exchange rate set by the People’s Bank of China (PBOC) is likely an equilibrium position that balances the undervalued trading sector with the overvalued, correcting real estate sector.

Conclusion on Valuation (00:17:10): The RMB is undervalued for goods/trade, but potentially overvalued for financial assets/real estate.

Additional Headwinds & Policy Alternatives

Yield Differential (00:14:47)

The substantial gap in sovereign bond yields—where US Treasury yields are much higher than Chinese bonds —makes a strong short-term case against RMB appreciation, as the US Dollar remains the major reserve and trading currency.

Trade Imbalances (00:20:49)

If the RMB is unlikely to appreciate significantly, trade imbalances (which are driving much of the appreciation call) may need to be addressed by industrial policy. The core issue preventing Chinese exporters (like EV companies) from raising prices is intense regional competition among Chinese provinces, which discourages any single region from making the first move.

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