© 2018 by Robert Person.  The views expressed on this website are my own and do not represent the official policy of the U.S. Army, Department of Defense, or U.S. Government.

alexschung
Apr 18, 2019
Edited: Apr 18, 2019

China cracking down on illegal underground forex trading in bid to control capital flight

 

https://www.scmp.com/economy/china-economy/article/2186008/china-cracking-down-illegal-underground-forex-trading-bid

This article by Frank Tang explains how the Chinese government has been cracking down on unregulated banks and the black market for foreign currency in order to maintain exchange rate stability. A severe offense faces up to 5 years in prison, and an extremely severe offense faces over 5 years. China has been experiencing some problems with capital flight as the government maintains strict capital controls. In 2015, the yuan experienced severe depreciation as there was severe capital flight, and the Chinese government has been attempting to crack down more severely on illegal foreign exchange transactions.

 

The Chinese yuan is pegged to the US Dollar, and is allowed to move within a tightly specified band set by the People’s Bank of China (PBOC). The goal of the PBOC and Chinese government is to keep the yuan within this band, without appreciating or depreciating too much. The Chinese government continues to pursue a stable yuan and thus limits both capital inflows and outflows, from foreign investors and domestic buyers of foreign assets and currencies, respectively. The government wants to maintain a currency level that is weak enough to support exporters, yet strong enough to prevent a financial bubble and capital escaping the country. Illegal capital outflows and a weaker yuan could also discount the yuan as a major reserve currency, which is a major goal of the PBOC. (https://www.scmp.com/news/china/economy/article/2141443/why-devaluing-yuan-no-no-china-amid-us-trade-war-fears) The yuan experiences upward pressure due to the demand for Chinese products, but the government intervenes regularly to maintain this peg by selling yuan and buying dollars. This practice has garnered criticism internationally, and especially from the current U.S. administration.

Monetary policy is one of the key talking points of the U.S.-China trade war, and there are valid points on both sides. On one hand, the Chinese government does suppress the appreciation of its currency, but China also fears going down the same path that Japan did following the Plaza Accord in 1985. In the Plaza Accord, Japan agreed to appreciate its currency, and lowered rates in order to minimize the natural upward pressure on the yen. This led to massive capital availability, the Japanese housing bubble and eventual collapse, which Japan is recovering from to this day. China is determined not to go down the same path, and it will be a challenge for U.S. negotiators to persuade the Chinese government to modify its current monetary policy.

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