Why has China not devalued the Yuan?

The single biggest driver of markets this year is the fact that China hasn't devalued

In 2018, when the first Trump administration imposed substantial tariffs, China devalued. In fact, that devaluation was so large that it provided a full offset to tariffs. This time around, even though US tariffs have gone up way more in a much shorter timeframe, China has kept the Yuan stable against the Dollar, a major departure from its 2018 playbook.

Indeed, it is only because China has kept the Yuan stable that markets are where they are, with the S&P 500 up 5 percent year-to-date and the Dollar down 10 percent. Had China devalued, global markets would have gone into a tailspin, dragging down the S&P 500 and pushing up the Dollar in a flight to safety. Indeed, we got a small taste of this in the week after “Liberation Day,” when a very small Yuan devaluation caused instability in the US Treasury market. We are living - therefore - in something of a simulation, where everything we see is at the behest of China.

So why hasn’t China devalued? One theory is that the substantial fall in the Dollar means China can get by without devaluation, because the fall in the Dollar helps it claw back competitiveness. The black line in the chart above shows the Dollar versus other advanced economies, while the blue line shows the trade-weighted Yuan. As the Dollar has fallen, it has dragged down the Yuan in trade-weighted terms, because the Yuan is de facto pegged to the Dollar.

The problem with this argument is that a fall in the trade-weighted Yuan does nothing to help insulate China against US tariffs. Only a devaluation of the Yuan against the Dollar can do that, so this argument really doesn’t hold water. I’ll be diving into China’s reluctance to devalue in a series of posts starting today. China’s reaction function on this is the single biggest driver of why global markets are where they are. Whether China continues to resist devaluation is the single most important question going forward.