China eyes Yuan devaluation to counter Trump tariffs: Will it work? – iShares MSCI China ETF (NASDAQ:MCHI)

China may be playing its biggest economic card yet.

According to sources cited by Reuters this week, Chinese policymakers are considering allowing the yuan to weaken significantly in 2025 to counter the economic impact of a potential 60% tariff on Chinese imports from the United States.

The move would mark a major shift in Beijing’s currency strategy as the country grapples with mounting economic pressures.

But will it actually work?

A Weaker Yuan: A Double-Edged Sword?

President-elect Donald TrumpThe proposed tariffs – 10% on all imports and a massive 60% on Chinese goods – have prompted Beijing to consider devaluation as a buffer. A weaker yuan could theoretically make Chinese exports cheaper and offset the sting of US tariffs.

Still, Beijing is walking a tightrope.

According to Lynn Song, an analyst at ING, the People’s Bank of China is expected to “mount a strong defense” of the yuan. The central bank is keenly aware that if the renminbi falls too sharply, it could trigger even tougher retaliatory measures from Washington.

In response to the rumours, Financial News, a PBOC-affiliated publication, insisted that the yuan remains on solid footing and predicted that the currency could stabilize and strengthen by the end of the year.

China’s real problem: a balance sheet recession

Tariffs are not China’s only problem.

The country is facing an economic struggle on several fronts with an imploding housing market, a weak stock market and slowing consumer activity.

“The gentle deflation of the housing market that politicians had in mind turned into a wicked balance recession,” said Alfonso Peccatiellochief investment officer at Palinuro Capital and founder of The Macro Compass.

“Trillion in wealth tied to real estate wiped out since 2021.”

A balance sheet recession is brutal. In this scenario, consumers and businesses prioritize repairing their finances over spending or investment, rendering typical monetary policy tools like interest rate cuts or currency devaluation largely ineffective.

This kind of economic slowdown is reminiscent of the Eurozone debt crisis of 2011-2012, when fiscal austerity made monetary policy largely ineffective at stimulating the real economy.

Beijing’s response so far

China’s political response has so far lacked courage, to say the least.

Authorities have floated mentions of small-scale fiscal stimulus, though those efforts lack the size and scope to move the needle.

The government has also set up mechanisms to discourage investors from shorting Chinese stocks with the aim of stabilizing markets. In addition, the central bank has lowered interest rates aggressively to increase liquidity.

Despite these interventions, the economy has failed to gain meaningful traction, leaving analysts and investors skeptical of Beijing’s strategy.

The iShares MSCI China ETF MCHI — a key benchmark that tracks Chinese stocks — remains nearly 50% below record highs reached in February 2021.

Why a weaker Yuan does not solve this

The idea of ​​weakening the yuan may sound like a magic bullet, but economists are not sold on the effectiveness of this strategy.

“In a balance sheet recession, consumers and businesses cannot be encouraged to spend more by lowering interest rates or weakening the currency,” Peccatiello said.

“They’re bleeding, and they’re seeing their net worth drop because of continued weakness in the real estate market.”

In short, a weaker currency will not rebuild destroyed wealth or restore confidence among Chinese households and businesses.

What is the right solution?

For Peccatiello, the solution for China may lie in implementing a large, targeted fiscal stimulus.

Instead of broad, unspecific measures, some suggest the government could consider targeting significant spending at struggling businesses and consumers.

The question remains: Will Beijing take significant steps toward fiscal stimulus?

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