The changing current and capital account of China

You cannot think about the Chinese currency devaluation without also reviewing their current and capital account. A close look shows that there has been significant changes over the last few years. Not keeping up with the China trade and capital flow story will give many a misconception about China and the foreign exchange market.

The balance of trade is still in a surplus although it is starting to trend down. The trade surplus is still higher than two years ago even with higher volatility. The close link between the dollar and CNY over the last few years  mean that the CNY has moved higher versus other currencies. This link may have hurt trade, but the bite from currency appreciation has not crippled the trade surplus.

 The trade surplus and income flows form the current account which has generally moved to post crisis highs.  By identity a current account surplus should be matched with a capital account deficit. Any differences will be made up in the official account. China has generally been in a current account surplus as well as a capital account surplus which leads to an increase in foreign reserves. This balances the international trade and capital flows. The current large capital deficit after a long period of surplus means official reserves will actually decrease.  This has changed the activity of PBOC which has to balance the international accounts and controls the money supply. Under conditions of large capital account outflows greater than the current account, the normal expected adjustment will be a depreciation of the currency. If the depreciation is small relative to what is expected or if there is a continued overvalue of the currency, markets will place more pressure on the central bank. This is what we are seeing in China.