• Research
  • Politika
  • About
Carnegie Russia Eurasia center logoCarnegie lettermark logo
  • Donate
{
  "authors": [
    "Michael Pettis"
  ],
  "type": "legacyinthemedia",
  "centerAffiliationAll": "dc",
  "centers": [
    "Carnegie Endowment for International Peace",
    "Carnegie Russia Eurasia Center"
  ],
  "collections": [],
  "englishNewsletterAll": "asia",
  "nonEnglishNewsletterAll": "",
  "primaryCenter": "Carnegie Endowment for International Peace",
  "programAffiliation": "AP",
  "programs": [
    "Asia"
  ],
  "projects": [],
  "regions": [
    "East Asia",
    "China"
  ],
  "topics": [
    "Economy",
    "Trade"
  ]
}

Source: Getty

In The Media

Why China Won’t Devalue the Yuan

Given China’s surplus economy, a weak currency could undermine growth and incite a trade war.

Link Copied
By Michael Pettis
Published on May 10, 2016

Source: Wall Street Journal

China’s central-bank governor, Zhou Xiaochuan, consistently denies that the country can devalue its way to faster growth, arguing that a falling yuan would harm the economy. From a purely economic point of view, Mr. Zhou is right. But that hasn’t stopped a growing number of analysts from calling for a substantially weaker currency.

The arguments in favor of devaluation are straightforward. China’s economy is slowing sharply, in part because of declining exports. After many years of current- and capital-account surpluses, the past two years have seen a large balance-of-payments deficit, and China’s central bank had to intervene heavily to support the yuan.

Developing economies usually respond in such situations by devaluing their currencies. Supporters of devaluation claim that China should do the same to regain export competitiveness and reverse capital outflows.

This comparison is mistaken. China is the world’s second-largest economy and runs the second-largest trade surplus in history. Developing economies that devalued successfully were much smaller, which made it easier for the world to absorb their export surge. They also devalued only after their overvalued currencies had caused persistently large deficits.

In contrast, the yuan is not overvalued. In fact it is undervalued, as Governor Zhou all but acknowledged in an interview with China’s financial magazine Caixin three months ago.

The current account shows why: China enjoys low unemployment and brisk wage growth. Economic activity is growing 6% to 7% while debt is growing two to three times faster. China’s trade partners, on the other hand, suffer high unemployment and can barely eke out 1% or 2% growth.

Normally China would import far more than it exports. But rather than running large deficits, China has large surpluses. While its exports declined last year, global exports declined even more. China is gaining export market share and its trade surplus is growing, neither of which suggests an overvalued currency.

To keep the yuan from falling the central bank has spent about $1 trillion of its $4 trillion in reserves. But China’s shrinking reserves are driven by net capital outflows. If money went abroad mainly because Chinese investors think foreign assets are relatively cheap, a weaker yuan would reduce capital leaving China by making foreign assets more expensive. But this isn’t the reason for the capital outflows.

Money leaves China partly to buy strategic assets, partly to hedge against rising political and financial uncertainty, and partly to reverse the notorious “arbitrage” of earlier years. From 2012 to 2014, some $1 trillion poured into China to speculate on an appreciating, higher-yielding yuan.

Chinese investors don’t care about the relative value of the yuan. Rather than restrain them, a devalued yuan might actually speed up their exit. This is what happened immediately after the change in the currency regime in August. Capital restrictions had to be tightened significantly to prevent even more money from leaving.

The main reason to oppose devaluation is that rather than boost growth, a weaker currency makes a surplus economy more precarious. Instead of changing relative prices, devaluation shifts income from consumption to savings.

In deficit countries—where savings are insufficient to fund investment—slowing growth scares off foreign inflows, causing investment to decline, which slows the economy further. By redirecting income from consumption toward savings, devaluation reduces dependence on foreign capital and keeps investment from dropping.

Surplus countries, however, don’t suffer from insufficient savings, and China’s savings are excessive. Yuan devaluation would simply reduce already-low domestic consumption and increase China’s reliance on investment and exports. This happened in Japan, where a substantially weaker yen further diminished consumption without kick-starting growth. For surplus countries, devaluation replaces sustainable demand—namely consumption—with the unsustainable demand of investment and trade surpluses.

In a global economy with growing trade tensions and weak demand, a devaluation that substantially boosts China’s trade surplus may ignite a trade war. If weak currencies only benefit much smaller economies with overvalued currencies and large current account deficits, it is hard to imagine why Beijing would risk devaluation.

The past three years have been terrible for international trade. China isn’t the only major economy suffering from weak domestic demand, but it has behaved far more responsibly than Europe and Japan, which have forced their adjustment costs onto the rest of the world. Maintaining the yuan’s value has been good for both China and the world. It wouldn’t help for Beijing to change strategy.

This article was originally published by the Wall Street Journal.

About the Author

Michael Pettis

Nonresident Senior Fellow, Carnegie China

Michael Pettis is a nonresident senior fellow at the Carnegie Endowment for International Peace. An expert on China’s economy, Pettis is professor of finance at Peking University’s Guanghua School of Management, where he specializes in Chinese financial markets. 

    Recent Work

  • Commentary
    What’s New about Involution?

      Michael Pettis

  • Commentary
    Using China’s Central Government Balance Sheet to “Clean up” Local Government Debt Is a Bad Idea

      Michael Pettis

Michael Pettis
Nonresident Senior Fellow, Carnegie China
Michael Pettis
EconomyTradeEast AsiaChina

Carnegie does not take institutional positions on public policy issues; the views represented herein are those of the author(s) and do not necessarily reflect the views of Carnegie, its staff, or its trustees.

More Work from Carnegie Russia Eurasia Center

  • Commentary
    Carnegie Politika
    Does Russia Have Enough Soldiers to Keep Waging War Against Ukraine?

    The Russian army is not currently struggling to recruit new contract soldiers, though the number of people willing to go to war for money is dwindling.

      Dmitry Kuznets

  • Commentary
    Carnegie Politika
    Japan’s “Militarist Turn” and What It Means for Russia

    For a real example of political forces engaged in the militarization of society, the Russian leadership might consider looking closer to home.

      James D.J. Brown

  • Commentary
    Carnegie Politika
    A New World Police: How Chinese Security Became a Global Export

    China has found a unique niche for itself within the global security ecosystem, eschewing military alliances to instead bolster countries’ internal stability using law enforcement. Authoritarian regimes from the Central African Republic to Uzbekistan are signing up.

      Temur Umarov

  • Commentary
    Carnegie Politika
    Lithuania’s Potash Dilemma Raises Questions About Sanctions’ Effectiveness

    What should happen when sanctions designed to weaken the Belarusian regime end up enriching and strengthening the Kremlin?  

      Denis Kishinevsky

  • Commentary
    Carnegie Politika
    Is There Really a Threat From China and Russia in Greenland?

    The supposed threats from China and Russia pose far less of a danger to both Greenland and the Arctic than the prospect of an unscrupulous takeover of the island.

      Andrei Dagaev

Get more news and analysis from
Carnegie Russia Eurasia Center
Carnegie Russia Eurasia logo, white
  • Research
  • Politika
  • About
  • Experts
  • Events
  • Contact
  • Privacy
Get more news and analysis from
Carnegie Russia Eurasia Center
© 2026 Carnegie Endowment for International Peace. All rights reserved.