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China’s currency: The middle way - Part 3 of 3

By: Mat Lystra, Sr. Research Analyst

In this three-part series on China’s currency, we have introduced the notion of the “impossible trinity” – an economic theory which says a country cannot simultaneously control its exchange rate and its monetary policy while allowing unrestricted cross-border capital flows. We want to determine if China can defy this theory by finding a balance among the three pieces of the trinity – a policy flexible enough that it could solve the conundrum by bending without breaking.

In part one of the series we introduced the concept and determined that China is partially-controlling the Renminbi (CNY)/USD exchange rate (see chart below), allowing for a measured devaluation against the US dollar. In part two we examined China’s monetary policy and concluded that while China continues to control its monetary policy, the magnitude of response could be constrained by inflation concerns brought on by support for the Renminbi. In this third and final part in our series, we turn our attention to the last piece of the trilemma – China’s mixed efforts towards open cross-border capital flows.

China’s current positioning in the impossible trinity


Source: FTSE Russell

As an index provider, capital mobility is a key consideration within the FTSE Russell country classification system.[1] Currency restrictions placed on foreign investors have been one of the primary reasons China’s domestic A-Share market has been kept out of standard emerging markets benchmarks. While China has been promoting currency accessibility, recent policies have been welcoming to foreign dollars but discouraging of un-purposed outflows of CNY (remember that the PBOC wants to soak up CNY liquidity in the global market).[2]

China’s current position within the trilemma can be aided by stimulating more demand from global investors.[3]  Achieving this can accomplish two goals simultaneously – provide a source of foreign currency entering the country and a need for CNY within the country (as foreign currency is exchange for CNY to buy equities). China’s recent changes to its QFII rules and planned expansion of its Stock Connect program are signals that market accessibility may continue to improve. In light of this, FTSE Russell continues to monitor China’s A-Share market for potential inclusion in FTSE GEIS and FTSE Emerging benchmarks. Once added to standard benchmarks by FTSE Russell and other index providers, A-Shares will likely provide a source of portfolio inflows which would create demand for Renminbi in exchange for foreign currency. For a complete review of FTSE Russell’s insights on China’s A-Share market please click here.

As illustrated above, we can see that the “impossible trinity” is most often framed as a government being able to control any two of the policy “corners” while allowing the third to be completely uncontrolled. China has chosen to pursue a middle way of flexibility within each of the three corners as the key to achieving its objectives -  in essence, “bending but not breaking”. Many believe that if this strategy, coupled with substantial foreign currency reserves, has the intended effect, the Renminbi may remain relatively stable in 2016 and beyond.


[1] For more information about FTSE’s country classification system please visit:

[2] Wildau, G. (2016). China targets offshore renminbi short selling with new reserve ratio.  The Financial Times, accessed on March 6, 2016 at:

[3] Johnson, S. (2016). China bond market shake-up seen to attract trillions of dollars.  The Financial Times, accessed on March 7, 2016 at:


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