Wall Street Journal: Xi Jinping Wants a Strong Yuan, But China's Economy Is Holding It Back

Chinese leader Xi Jinping does not like a weak yuan. At least in his view, yuan depreciation is a humiliating display of weakness that he does not wish to expose before the world. Yet, according to a respected foreign exchange expert in Washington, the yuan's exchange rate is undervalued by 20% to 30% relative to its true value. This is the core paradox explored in this week's column. This perspective emerged from an extensive conversation I had with Mark Sobel. Sobel formerly served as a senior official at the U.S. Department of the Treasury, with decades of experience in international monetary policy, and later represented the United States at the International Monetary Fund (IMF). He currently serves as chief economist at the Official Monetary and Financial Institutions Forum, an independent organization. Sobel detailed how the effects of a weak yuan are deeply embedded in China's economic structure.

There is an old adage in economics: a country's current account balance equals the difference between savings and investment. China's savings are enormous. Partly due to the design of its financial system, and partly because its social safety net is so thin, ordinary households feel compelled to save heavily for old age and medical emergencies. As Sobel noted, the once-stable 'iron rice bowl' of lifelong employment is long gone.

These vast pools of savings are funneled by state-owned banks to state-owned enterprises and favored industries such as artificial intelligence (AI), semiconductors, and electric vehicles. The goal is to keep production lines running, even when domestic demand cannot absorb the output. Some industries have achieved impressive results. But much of the capacity falls into what Chinese officials now call 'neijuan'—a vicious cycle in which companies and local governments keep factories operating despite a lack of economic rationale, merely to meet growth targets or preserve jobs.

Regardless, there is a massive mismatch between production capacity and weak domestic demand, further suppressed by low consumer confidence, near-zero inflation, and a collapsing real estate sector. This excess capacity must find an outlet—exports.

According to Sobel's estimates, China's manufacturing export surplus alone exceeds 10% of GDP. This situation continues to intensify trade tensions, what many economists refer to as 'China Shock 2.0'.

Sobel explains that when current account data is fed into the IMF's exchange rate assessment framework, it leads to a startling conclusion: the yuan is undervalued by 20% to 30%.

True, the yuan has strengthened somewhat this year. But Sobel's second point casts cold water on this optimism. Looking at inflation-adjusted real exchange rates, the yuan has actually fallen by about 15% since 2022. A crucial point is often overlooked: if U.S. inflation is 3% while China's is near zero, even a stable bilateral exchange rate effectively grants China a 3% annual boost in competitiveness. When inflation is near zero, standing still is a form of de facto depreciation.

So what has driven the yuan's rise this year? Sobel attributes it to a confluence of factors: current account surplus, Trump-induced dollar weakness, and exporters' repatriation behavior. Exporters, sensing Beijing's tolerance for yuan appreciation, have brought their dollar earnings back home rather than keeping them overseas, pushing the yuan upward gradually. (This herd behavior works both ways: exporters hoard dollars when the yuan falls and rush to convert when it rises.)

Moreover, there is intense debate over how much behind-the-scenes state-owned banks are controlling the pace of appreciation. Sobel acknowledges that no one knows the true extent of such intervention.

Through my frontline interviews, I found another subtle variable beyond Sobel's economic analysis. Xi Jinping's aversion to yuan depreciation is not driven by a desire to shift toward a consumption-led economy, but by concerns over prestige and geopolitics.

I recall that earlier this year, after Donald Trump returned to the White House and threatened new tariffs, the People's Bank of China faced a dilemma. Officials knew that yuan depreciation could cushion the impact of tariffs on exporters, as it did during the first U.S.-China trade war. But they also knew the leadership disliked a weak yuan. Multiple sources indicate that PBOC officials spent enormous energy internally balancing this contradiction.

Then, Trump's stance softened repeatedly, entering what traders call 'TACO mode'—'Trump Always Creates Opportunities'. Tensions eased, and the yuan stabilized and strengthened. According to my sources, PBOC insiders finally breathed a sigh of relief.

Where is the yuan headed? Sobel expects no major revaluation, but rather a continuation of Beijing's current strategy: slow, cautious appreciation, prioritizing stability through precise control. Because the yuan starts from a significantly undervalued base, Beijing has ample room to allow appreciation without harming competitiveness. As Washington and Brussels grow increasingly impatient with Chinese exports, this provides a useful buffer in the current climate.

Sobel points out that Beijing has shown no willingness to fix the underlying structural flaws—the entrenched growth model of excessive savings, state-led investment, and export dependence—that originally caused yuan weakness and weak consumption. Thus, the status quo persists: exports remain central, trade tensions simmer, and the dream of a strong yuan boosting household consumption remains distant.

A cheap currency is not a systemic flaw in China's growth model—it is an inherent feature. Xi Jinping's personal preference for a strong yuan alone is insufficient to change this reality.