McGeever: The yuan's value is not as low as you might think.

How much of the global imbalances are caused by China's undervalued yuan? Beijing's huge surpluses may not be the best indicator of what is going on.

The?yuan (also known as the Renminbi) is currently trading around 6.80 to the dollar, its highest nominal level in over three years. However, based on the accepted economic fundamentals, it should be much stronger.

China's official balance of current accounts surplus was $735 billion last year, which is just a little over 3% of gross domestic product or about 30% combined global current account deficits. Its official trade surplus was $1.2 billion, or about 6% GDP and almost 40% of global trade surpluses. Both figures represent record-breaking levels in nominal terms and are huge for one country.

If these data points determined the value of the yuan, it would be impossible to deny that the exchange rate should be significantly higher.

The flow of money has not only been one-way.

Capital has been flowing out of China in large amounts over the past few years as the country has struggled with deflation and a historic property crash. Money from domestic investors, businesses and institutions has also been sent overseas.

This shows that the debate surrounding the Chinese currency has a nuanced nature.

30% UNDERVALUED?

The yuan's value is undervalued.

In its February country report, the International Monetary Fund stated that China's external position is "assessed to be stronger than implied by medium-term basic fundamentals and desirable policy." The yuan is still falling in real terms because of China's low rate of inflation.

According to IMF economists, the renminbi depreciated by real value four years in a line, and has registered a total decline of 14% since 2021. According to IMF economists, China's real exchange rate is up to 20% below its actual value.

Brad Setser, a China expert, and Mark Sobel are both former U.S. Treasury officials. They say that the yuan may be undervalued up to 30%. Setser has argued for years that China's official data on balance of payments understates its real surplus. Customs data, he says, is a more accurate barometer. According to that measure, China's trade surplus would be one?percentage-point higher than GDP.

TRILLIONS GO IN THE OTHER DIRECTION

There is no doubt that China has large external surpluses, but this means that the capital outflows - the mirror image of the country's current account – must be huge.

Recent years have seen a particularly large outflow of portfolios. The concerns over China's economic growth, the trade tensions between the U.S. and China, and the growing interest rate gap in developed economies has pushed domestic capital abroad.

Institute of International Finance data shows that China has experienced cumulative net capital outflows of 2,85 trillion dollars since the beginning of this decade. This comprehensive picture includes portfolio flows, direct investments, banking, and other investment flows by residents and non-residents.

The data shows that China is still able to run large external surpluses, while its domestic firms, households and institutions continue to look for investment opportunities overseas because the growth and returns there are better, or because they wish to diversify.

Jonathan Fortun, IIF, says that the financial account dynamics make it difficult to argue for an extremely large, persistent undervaluation. However, they don't rule out anything more moderate.

It is important to keep this in mind when discussing the fair value of the yuan. A China expert who spoke at the IMF's Spring Meetings last week in Washington said that the yuan may have been undervalued by 15%, rather than the 25-30% previously thought.

What is the biggest driver of imbalances? Look elsewhere

The U.S. appears to be the main driver of global imbalances that are currently being warned by the IMF, despite the fact that China is receiving a lot of heat for its undervalued exchange rate in spite of large external surpluses.

IMF, Brookings Institution, and Centre for Economic Policy Research reports have shown that U.S. trade deficits are a larger share of global trade deficits than China's share of global surpluses.

In 2006, when global imbalances peaked, the U.S. was responsible for 60% of all current account deficits combined, measured as a percentage of global GDP. This is now closer to 70 percent.

Even though the noise about the undervaluation may become louder, it is arguably the overvaluation the dollar that remains a major concern.

Save the date! On April?23, at 1300 GMT/9 a.m. ET, ROI columnists Mike Dolan & Jamie McGeever, along with LSEG, will be hosting a webinar entitled "Markets Unpacked With Open Interest: Rethinking Safe Havens in Uncertain Times." Sign up here.

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(source: Reuters)