The debate over China’s manufacturing overcapacity has ignited intense discussions among policymakers.
During her trip to China in April, U.S. Treasury Secretary Janet L. Yellen raised concerns about the impact of “artificially cheap Chinese products flooding the global market,” questioning the sustainability of foreign firms, echoing similar concerns from a decade ago.

Yellen’s observation holds merit: the ongoing Sino-American trade tensions have paradoxically bolstered China’s export competitiveness. In 2023, China’s share of global exports rose to approximately 14%, a 1.3 percentage point increase from 2017, pre-trade conflict levels. More notably, China’s trade surplus surged to around $823 billion in 2023, nearly doubling its 2017 figure.
A decade ago, China’s trade surplus was primarily attributed to an undervalued yuan (CNY). Present circumstances exhibit some parallels. Research indicates that in 2023, the CNY was undervalued by 16% against the dollar, propelling China’s exports and trade surplus.

This evaluation stems from the significant inflation rate gap between the United States and China over the last two years, with the U.S. experiencing a 10-percentage point higher inflation rate. Based on purchasing-power-parity calculations, the CNY should have appreciated by 10% against the dollar; instead, it depreciated by 11%, signifying a 21% undervaluation against the dollar.

Yet, short-term exchange rates are predominantly influenced by the interest-rate differential rather than inflation rates. Econometric methods, integrating factors like interest-rate spreads and economic growth, were employed to estimate the ideal CNY exchange rate. Comparative studies reveal that the degree of CNY undervaluation surpasses that of major ASEAN currencies over the past two years and notably exceeds the undervaluation observed during the last round of U.S. Federal Reserve rate hikes from 2015 to 2018.

Remarkably, there is scant evidence suggesting that the Chinese government manipulates the exchange rate. Even the U.S. acknowledges China’s non-manipulative behavior in recent years, highlighting significant progress in China’s exchange-rate system reforms. Consequently, the volatility of the CNY exchange rate has intensified.

However, the lingering undervaluation of the CNY prompts inquiry. Analysis of the balance of payments indicates substantial net capital outflows in 2022 and 2023, surpassing $500 billion, despite previous inflows exceeding $400 billion. China’s substantial current-account surplus hasn’t spurred CNY appreciation due to these capital outflows, rendering exchange-rate adjustments ineffective in balancing trade.

These capital outflows aren’t solely driven by changes in the interest-rate spread but also by noneconomic factors, including China’s regulatory policies. Recognizing this, the Chinese government recently began incorporating noneconomic policies into its evaluation framework.

Moreover, escalating Sino-American tensions have led to U.S. policies discouraging investment in China, further exacerbating capital outflows and CNY undervaluation. Legislative measures under consideration in the U.S. Congress could exacerbate these trends.

In this fraught geopolitical climate, resolving Yellen’s concerns and achieving equilibrium necessitates China’s development of a consistent mechanism for evaluating the impact of its noneconomic measures and the U.S. easing its restrictive policies for the mutual benefit of both nations.