(Yicai) Aug. 14 -- China’s trade surplus in goods reached a record high of USD1.19 trillion in 2025 and remained at a similar level in the first six months of 2026. Last month, German Chancellor Friedrich Merz said that the Chinese yuan had been undervalued by 25 percent for many years.

In his speech at the University of Cologne, Merz argued that the European Union could not compete with China, which he described as a country which manipulates its currency, no matter how innovative it is. He called for a “political exchange-rate dialogue” with China.

I recall that more than two decades ago, the president of the European Central Bank, Jean-Claude Trichet, also warned that an undervalued yuan could undermine the European economy. In fact, it was precisely because of Trichet’s concerns that the ECB created its first economist position dedicated to studying China’s economy. I joined the ECB in that role, and my first assignment was to study the yuan’s equilibrium exchange rate.

More than two decades later, history appears to be repeating itself. However, the fundamentals underpinning the yuan exchange rate today are significantly different from those in the first decade of this century. A large trade surplus alone is therefore not sufficient evidence that the yuan is undervalued.

Surplus Swings

Looking back at China’s current-account surplus as a share of gross domestic product since the beginning of this century, the global financial crisis that broke out in 2007 marked a major turning point. From 2001 to 2007, China’s current-account surplus rose steadily from about 1.3 percent of GDP to 9.8 percent. From 2008 to 2018, however, the ratio fell back to nearly zero.

Why did the current-account surplus decline so sharply during that decade? History points to two key factors.

The first was, of course, currency appreciation. The People’s Bank of China began exchange-rate reform in July 2005, allowing the redback to strengthen by 2 percent in a one-off adjustment. Despite interruptions caused by shocks including the global financial crisis and the European debt crisis, the yuan broadly appreciated against the US dollar, rising from around CNY8.28 per dollar in early 2005 to CNY6.04 in early 2014. The average exchange rate was CNY6.60 against the dollar in 2018. The maximum appreciation of the yuan’s nominal exchange rate exceeded 37 percent.

A stronger currency tends to support imports while making exports less competitive, helping reduce the current-account surplus.

The second factor was a significant strengthening in domestic demand. After the 2008 financial crisis, Western economies entered a prolonged period of crisis and recession. China, on the other hand, launched a CNY4 trillion (USD593.2 million) economic stimulus package at the end of 2008, significantly boosting investment and consumption. With policy support, the property market experienced a prolonged boom and became one of the main pillars of domestic demand. As a result, China’s economic growth remained well above that of Western countries.

Stronger domestic demand drove a corresponding increase in imports. For example, China’s crude steel output soared from 500 million tons in 2008 to 920 million tons in 2018, while iron ore imports surged from 440 million tons to 1.06 billion tons over the same period. At the same time, China’s export growth slowed sharply amid weak overseas demand.

Key Differences

In recent years, China’s current-account surplus as a share of GDP has risen significantly again, reaching 1.4 percent in 2023, 2.5 percent in 2024 and 3.8 percent in 2025.

The situation is very similar to the period leading up to 2007, when the redback was on an appreciation path. Does this mean the yuan also has substantial room to strengthen today?

I believe there are two major differences between China’s economy today and that of the early 2000s, suggesting that the scope for yuan appreciation may be limited.

The first key difference is the direction of flows in the financial account.

In the early 2000s, China’s current-account surplus rose alongside a substantial surplus in the financial account excluding reserve assets. In fact, before the 2005 exchange-rate reform and the gradual appreciation of the yuan, the non-reserve financial-account surplus often exceeded the current-account surplus.

Overall, at the start of this century when the yuan faced appreciation pressure and actually appreciated, China was running twin surpluses in its current and capital financial accounts, while its foreign-exchange reserves continued to rise. Data show that China’s reserve assets, excluding valuation effects, increased by about USD1.3 trillion between 2002 and 2007.

The situation is very different today. China’s current-account surplus increased sharply from USD260 billion in 2023 to roughly USD740 billion in 2025, but the capital finance account deficit widened from USD240 billion to USD820 billion over the same period, broadly offsetting the current-account surplus. In fact, China’s net acquisition of reserve assets fell by USD100 billion between 2023 and 2025.

The capital finance account deficit is related to the inverted interest-rate differential between China and the United States. The current yield on 10-year US Treasuries is 4.7 percent, while the interest rate for 10-year Chinese government bonds is just 1.7 percent.

Given renewed uncertainty over US inflation, expectations of another Federal Reserve rate hike have not disappeared. Meanwhile, China’s GDP growth slowed significantly in the second quarter and the PBOC has indicated that it will continue to pursue a “moderately loose” monetary policy. The inverted interest-rate differential between China and the US is therefore unlikely to change in the short term.

Given the substantial interest-rate gap and continued capital outflows, it appears that the redback has limited room for appreciation.

The second major difference is labor productivity.

China’s overall labor productivity rose steadily from 2001 to 2007, but since 2011 it has been on a downward trend, according to data released by the National Bureau of Statistics. Other indicators, including slower wage growth among migrant workers and declining returns on investment by industrial enterprises, also suggest that production efficiency growth in China may have slowed down in recent years.

Although China’s robust exports might appear to indicate high international competitiveness, the data do not show a corresponding sharp increase in labor productivity. Moreover, high-tech firms and export-oriented companies, such as new-energy vehicle manufacturers, tend to have lower profit margins.

Data from listed companies show that the return on total assets of firms in the six high-tech manufacturing industries defined by the National Bureau of Statistics not only declined steadily from 2017 to 2024 but also remained below that of the entire manufacturing sector.

If China’s labor productivity growth, particularly in manufacturing, is relatively weak, the Balassa-Samuelson effect also suggests that the yuan does not have significant room for appreciation.

Boosting Demand

China’s share of the global economy is far larger today than it was in 2007. As a result, the impact of a rising trade surplus as a share of GDP on the global economy is also much greater.

China’s customs-based goods trade surplus amounted to about 1 percent of global GDP in 2025, nearly double the 0.5 percent recorded in 2007, according to my calculations. Against a highly complex geopolitical backdrop, China should pay attention to the spillover effects of its expanding trade surplus.

Macroeconomic identities show that a trade account surplus reflects a gap between domestic savings and investment. Drawing on historical experience, boosting domestic demand to address the imbalance between strong supply and weak demand in China may be a better way to mitigate the impact of a widening current-account surplus on other economies.

There is already broad domestic consensus on this point, which is that the key to spurring domestic demand lies in consumption.

Many economists have also put forward valuable suggestions, including strengthening the social safety net, significantly increasing childbirth subsidies, improving pensions to farmers and rural medical insurance, and accelerating the urban integration of China’s 290 million migrant workers. If implemented, these measures will undoubtedly have a significant impact on boosting domestic demand.

The wealth effect is also important for stimulating consumption. For Chinese households, real estate represents a major source of wealth. A recent meeting held by the Political Bureau of the Central Committee of the Communist Party of China also called for stabilizing the property market. Government departments should take various actions to implement the policy direction laid out at the Politburo meeting and try to prevent falling property prices from weighing on household consumption and domestic demand.

(The author is chief economist at Chinese e-commerce giant JD.com.)

Editor: Kim Taylor