In the Yuan Overvalued? This Chart Says Yes

China hitched its wagon to U.S. dollar monetary policy during the 2000s, sterilizing dollar inflows via massive issuance of renminbi (CNY) into the domestic economy. Every USD that came into China was swapped at a rate of 8.28 CNY (lower after the peg was allowed to rise). Currency inflows devalued the yuan in the direction of the peg because it was fueling money and credit growth. (The currency would rise in the short-run as it does during every boom, but the long-term impact would be a bust and depreciation.) There were two values to the yuan, the "real" unknown value (due to no market price), and the peg at 8.28 to $1. As long as the peg was in effect, the real value of the yuan was falling towards the peg. Chinese authorities did not declare the yuan fairly valued until it reached about 6 to $1. When it reached this point, it was already at its most expensive versus foreign currencies since the early 2000s.

The yuan faced depreciation pressure in 2008 and since 2011. Massive inflation should have caused the yuan to depreciate. Instead, Chinese yuan moved in the opposite direction due to maintaining the peg for too long. Monetary policy with the U.S. also diverged. China wants to lower interest rates and devalue yuan; USA is raising interest rates and dollar is appreciating. The U.S. dollar rally puts continual pressure on CNY to rise. The devaluation to this point has only held the CNY level versus USD Index basket; it is still rising versus EM currencies.CNY cannot continue to rise with the dollar.

A depreciation of 15% takes CNY back to an expensive valuation over the past 15 years. A depreciation of 35% takes CNY back to its cheapest valuation in the past 15 years. These numbers are versus USD and assume no USD depreciation (which would reduce the numbers) or appreciation (which would increase them).