China Eyes Yuan Devaluation To Counter Trump's Tariffs: Will It Work?

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 by the United States.

This 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 Trump's 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 U.S. tariffs.

Yet, 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 acutely aware that if the renminbi falls too sharply, it could trigger even harsher retaliatory measures from Washington.

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

China's Real Problem: A Balance Sheet Recession

Tariffs aren't China's only problem.

The country is facing a multi-front economic battle, with a housing market that's imploding, a weak stock market, and slowing consumer activity.

"The gentle de-leveraging of the housing market that policymakers had in mind turned into a vicious balance sheet recession," said Alfonso Peccatiello, chief investing officer at Palinuro Capital and founder of The Macro Compass.

"Trillions in wealth tied to real estate have been wiped out since 2021."

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

This type of economic slowdown recalls the eurozone debt crisis of 2011-2012, when fiscal austerity measures rendered monetary policy largely ineffective in stimulating the real economy.

Beijing's Response So Far

China’s policy response thus far has lacked courage, to say the least.

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

The government has also set up mechanisms to deter investors from shorting Chinese stocks, aiming to stabilize markets. Additionally, the central bank has slashed interest rates aggressively to boost liquidity.

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

The iShares MSCI China ETF MCHI – a key benchmark tracking Chinese equities – continues to remain nearly 50% below its record highs achieved in February 2021.

Why a Weaker Yuan Won't Fix This

The idea of weakening the yuan might sound like a magic bullet, but economists aren't sold on the effectiveness of this strategy.

"In a balance sheet recession, consumers and corporates can’t be encouraged to spend more by cutting interest rates or weakening the currency," Peccatiello said.

"They are bleeding, and they see their net worth declining due to continued weakness in the property market."

Simply put, a weaker currency won’t rebuild shattered wealth or restore confidence among Chinese households and businesses.

What's The Real Solution?

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

Rather than broad, unspecific measures, some suggest that the government could consider directing significant spending toward struggling corporations and consumers.

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

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