The overvalued dollar is weakening: How should the renminbi respond?

It seems that many people believe the RMB will depreciate significantly once it achieves full convertibility. I've spoken with many people, from ordinary citizens to financial scholars and even some high-ranking officials, and they all share this view. Experience tells us that consensus is often wrong. Therefore, in July of last year, I published a long article, "Can the RMB Take a Daring Leap?", suggesting that the RMB should attempt to achieve full convertibility under the capital account as soon as possible, thereby accelerating its internationalization process. Recently, the journal *Qiushi* published an important article pointing out that the goal of a financially strong nation is "to possess a strong currency, widely used in international trade, investment, and foreign exchange markets, and to have the status of a global reserve currency." However, I have always believed that the RMB will not experience significant depreciation or capital flight after achieving full convertibility. This article will further explain why the US dollar is overvalued and the RMB is undervalued, and that, given the current weakening of the US dollar, the internationalization of the RMB should be accelerated. Purchasing Power Parity (PPP) – Reflecting the Valuation Levels of Currencies Those who invest in stocks know what the price-to-earnings ratio (P/E ratio) is. The lower the P/E ratio, the cheaper the valuation. For example, whenever the stock market enters a long bear market, everyone says that stock prices are undervalued because the P/E ratio is low, hoping that a stabilization fund will enter the market; whenever the stock market is booming and the average P/E ratio is at a historical high, the authorities will accelerate the IPO process and control the scale of financing to curb market frenzy. So, what is the current valuation level of various currencies? We can use Purchasing Power Parity (PPP) to measure it. The PPP exchange rate is a currency exchange rate calculated by comparing the price levels of the same goods and services in different countries, and is intended to measure the actual purchasing power of various currencies. Below is a table shown in the article "Can the RMB Attempt a Daring Leap?": [Table content: Comparison of Market Exchange Rates and PPP Exchange Rates of Various Countries] The image above shows that, except for the Swiss Franc, which has a higher exchange rate against the US dollar than its PPP exchange rate, all other currencies have lower exchange rates than their PPP exchange rates. For example, the market exchange rate of the RMB against the US dollar was 7.19 in June 2025, and is now 6.96, but according to purchasing power parity, it is only about 3.43. Overall, the gap between the market exchange rate and the PPP exchange rate in developed countries is relatively small, while the gap between the market exchange rate and the PPP exchange rate in developing countries is usually larger. This indicates that the market exchange rate of developed countries is closer to their actual purchasing power, and their currencies are relatively less undervalued. So, why are the currencies of developing countries generally undervalued? Let's discuss the reasons behind this. Why is the RMB undervalued for a long time? — Weak liquidity is the main reason. I remember when I first went to university in Shanghai, my family gave me 30 jin of national grain coupons. During the planned economy era, most goods required coupons to purchase. Even durable goods like watches, bicycles, and sewing machines required coupons; simply paying with cash wasn't enough, coupons were needed. Grain coupons, being the most liquid form of ration coupon, could be exchanged for goods at farmers' markets. National grain coupons were more valuable than Shanghai grain coupons, with an exchange rate of approximately 1:1.7. I used 30 jin of national grain coupons to exchange for two jin of hairy crabs to share with my roommates. If I had used Shanghai grain coupons, I would have needed 50 jin to get two jin of crabs. Why were national grain coupons more valuable than local ones? Because national grain coupons were valid nationwide, while Shanghai grain coupons were only valid in Shanghai, thus limiting their applicability. This reminds me of my country's A-share and B-share markets. Initially, the B-share market was only open to overseas investors and some domestic institutional investors, resulting in the phenomenon of different prices for the same shares with the same rights in the A-share and B-share markets. Later, B shares were also opened to domestic individual investors, leading to a surge in B share prices. This demonstrates that expanding the scope of circulation is beneficial for boosting stock prices. However, even today, the price difference between A shares and B shares of the same listed company remains relatively large. How can this be explained? It's likely related to turnover rate; the turnover rate of A shares is much higher than that of B shares. In other words, stock price and liquidity are positively correlated—higher liquidity leads to higher stock prices. Similarly, the price difference between A shares and H shares follows the same logic. Although the Stock Connect program has been running for 12 years, the current price difference between A and H shares is still around 20%, much smaller than the A-B price difference. The reason is that the activity level of A shares (measured by turnover rate) is higher than that of Hong Kong stocks. I used to be puzzled by the persistently high prices of small and mid-cap stocks in the A-share market. Later, after comparing the trading structures of the Chinese and American stock markets, I understood: In 2024, A-shares with a market capitalization below 30 billion RMB accounted for a staggering 63.4% of trading volume; while the corresponding market capitalization share in the US stock market was only 7.1%. Therefore, the deviation between the stock prices and valuation levels of small and mid-cap stocks in the US stock market is relatively low. Through the above analysis, it's not difficult to explain why the market exchange rate of the RMB is far lower than the PPP, meaning the RMB is undervalued by more than half. First, although the RMB is the fifth largest international currency, compared to the US dollar, its share as a payment currency globally is relatively low, which is inconsistent with China's status as the world's second-largest economy and largest exporter.

The percentage of major currencies in international payments (%)

Data source: SWIFT, WIND, Zhongtai International

According to the monthly data published by the Society for Worldwide Interbank Financial Telecommunication (SWIFT),

20Geographical share of offshore RMB payments in 2024

Data source: WIND, Zhongtai International

As from

Major Currencies' Share in Official Reserves (%)

Data Source: IMF, Zhongtai International

Correspondingly, China's official foreign exchange reserves are the largest in the world, and its US dollar reserves are also the largest globally.

In contrast, China's official foreign exchange reserves are the largest in the world, and its US dollar reserves are also the largest globally.

The US dollar, as the global reserve currency, accounts for about 60% of global reserve currencies; however, by the end of 2025, it had fallen below 60%. The three reasons mentioned above—smaller liquidity, smaller liquidity area, and smaller global holdings—explain why the gap between the RMB's market exchange rate and its purchasing power parity (valuation) is so large. The same reason applies to the more severe undervaluation of other developing country currencies, because these currencies have even smaller liquidity and liquidity areas. Exchange rates are also constrained by credit premiums: Why is the Swiss franc so strong? In 2025, the Swiss franc appreciated by 12.7% against the US dollar, becoming the world's strongest currency. However, since it was mentioned earlier that the better the liquidity of a currency, the higher the market exchange rate will be, and the Swiss franc has very little global liquidity, why is the PPP (Public-Private Partnership) rate of the Swiss franc against the US dollar higher than its market exchange rate? This is another major factor affecting exchange rates—credit. Because paper money is fiat money, as Marx said, gold and silver are not naturally money; money is naturally gold and silver. Paper money replacing gold and silver is essentially a form of credit agreement. The higher the creditworthiness of a paper currency, the more willing people are to hold it; that is, the greater the demand, the higher the exchange rate. Statistics on the exchange rate changes of major currencies against the US dollar from 1990 to the present show that, except for the Swiss franc and the Singapore dollar, other currencies have depreciated against the US dollar to varying degrees. So, why are these two currencies so strong? These two countries share characteristics that other countries do not: stable political systems, undisputed territories, neutrality in global diplomacy, and no enemies; developed economies, fiscal surpluses, healthy balance sheets, and a trade surplus. Most currencies have depreciated against the US dollar since 1990. (Image source: WIND, Zhongtai International) After World War II, and following 80 years of peace, it is truly remarkable that countries can maintain fiscal surpluses and trade surpluses. They must strictly adhere to fiscal discipline, be free from corruption, avoid unnecessary disruptions and extravagance, and uphold integrity. Therefore, the creditworthiness of their currencies is first-rate. To this end, let's introduce a concept: every country's currency has a market exchange rate and purchasing power parity (PPP). The former is determined by supply and demand, while the latter reflects valuation. The size of the difference between the market exchange rate and PPP is determined by the level of risk premium, i.e.: Risk Premium = Liquidity Premium + Credit Premium. Let me explain the term "premium". In the financial field, risk premium specifically refers to the additional return investors demand beyond the risk-free rate for taking on extra risk. This concept is extended to exchange rates; the difference between the market exchange rate and the PPP (Public-Private Partnership) rate is considered the risk premium, i.e., compensation for liquidity and credit risk. Or we can change the formula as follows: Market exchange rate = PPP + liquidity premium + credit premium. For example, assuming the USD/CNY exchange rate is 1:7, PPP is 1:3.5, liquidity premium is 2.5, and credit premium is 1, then the market exchange rate (7) = 3.5 (PPP) + 2.5 (liquidity premium) + 1 (credit premium). When liquidity is very high, the liquidity premium can be negative; when creditworthiness is very high, the credit premium can also be negative. The sum of the two is the risk premium, which can be negative, positive, or zero. For example, the risk premiums of the Swiss Franc and the Singapore Dollar are generally negative or zero, mainly because the credit premium is negative, meaning the creditworthiness is very high, which compensates for the insufficient liquidity of the local currency. Regarding credit premiums, there is another noteworthy case: when the Shanghai Stock Exchange opened, there were only eight stocks, commonly known as the "Old Eight Stocks." After listing, their price-to-earnings ratios were extremely high, making it difficult to see any investment value. However, because there was no delisting system at the time, nor were there any regulations on asset injections or backdoor listings, the "Old Eight Stocks" enjoyed preferential credit treatment—they could continuously undergo asset restructuring. In the 25 years from 1991 to 2016, their average stock price increased 230 times, that is, an average annual increase of over 24%, completely outperforming Buffett's annualized investment return. The overvalued US dollar is on a downward trend. The twin deficits of the US economy are long-standing, indicating that the US economy has consistently faced significant problems. The US dollar index fell from 118 points in 2001 to 72 points in 2008. This decline caused panic among central banks worldwide, leading to a 43-year period of reducing gold reserves after 2008, followed by increased gold purchases. However, the US dollar index did not weaken indefinitely but instead trended upwards, recovering to around 112 points in 2022.

US Dollar Index and Real Effective Exchange Rate of the RMB

Source: WIND, Zhongtai International

However, after Trump is re-elected president in 2025, the US Dollar Index has fallen from 107 to the current 97, and may continue to decline.

Source: WIND, Zhongtai International

However, after Trump is re-elected president in 2025, the US Dollar Index has fallen from 107 to the current 97, and may continue to decline.