Yuan Hits 3-Year High; Interview with Xiang Songzuo: Exchange Rate Isn't Economic Valuation

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Entering 2026, the renminbi (RMB) has not only broken through the psychologically significant threshold of "7" against the US dollar but has continued its upward momentum, showing strong signs of further appreciation.

Recently, both onshore and offshore RMB exchange rates against the US dollar have risen, reaching new highs for the year and hitting their highest levels since March 2023.

Xiang Songzuo, President of the Greater Bay Area Finance Research Institute in Shenzhen, recently gave an exclusive interview to National Business Daily, offering an in-depth analysis of the underlying logic of exchange rate movements from the perspective of the nature of exchange rates.

He pointed out that, in the long term, there may be a correlation between exchange rates and the real economy, but in the short term, the correlation is very weak. From a short-term perspective, the main factor driving exchange rate fluctuations is market speculation sentiment, i.e., participants' expectations.

The Main Factor Behind Short-Term Exchange Rate Fluctuations Is Market Participants' Expectations

NBD: From a medium- to long-term perspective, what do you believe are the key factors determining exchange rate trends?

Xiang Songzuo: Experience over the past few decades shows that most traditional economic theories explaining exchange rates have proven inadequate. Under a floating exchange rate regime, exchange rates have evolved into prices that reflect instantaneous changes in speculative markets, becoming decoupled from the real economy. For the real economy, exchange rate movements have become a source of noise, creating unnecessary risks—especially evident in relatively short-term fluctuations. For example, throughout 2025, the RMB depreciated by over 9% against the euro. Does this mean China's economy underperformed relative to the Eurozone in the past year? The facts suggest otherwise, as the Eurozone economy itself has not been in good shape.

In my 2014 book The New Capital Theory, I discussed how, under the dominance of global financial capitalism, virtual economies such as global monetary and financial markets have expanded rapidly and become disconnected from the real economy. In this context, traditional exchange rate theories—such as purchasing power parity and interest rate parity—have become ineffective. A new theoretical framework is needed to analyze exchange rate markets.

In the era of floating exchange rates, the exchange rate market and the real economy now operate in two relatively independent "worlds." While a correlation may exist over the long term—say, more than 20 years—the short-term correlation is very weak.

From a short-term perspective, if we are to identify the main factor driving exchange rate fluctuations, it is market speculation sentiment, i.e., participants' expectations. These expectations themselves generate various forms of noise. For instance, if market participants expect the US dollar to depreciate and the RMB to appreciate, they will buy RMB in succession. This buying pressure then drives the RMB to appreciate, confirming the initial expectation.

NBD: Since the fourth quarter of last year, the RMB has appreciated significantly, and at the start of 2026, it has steadily entered the "6" range. How do you view this change?

Xiang Songzuo: Under a floating exchange rate regime, there is a connection between the real economy and exchange rates, but it is no longer close. In this context, if we must identify what determines exchange rates, the honest answer is that today's exchange rates are primarily determined by speculative trading in the foreign exchange market, rather than by changes in the real economies of the two countries.

So, what primarily influences foreign exchange trading? It is essentially the expectations of market participants. The most direct information shaping these expectations is the monetary policy actions of central banks. For example, if the market expects the Federal Reserve to cut interest rates, it will anticipate a decline in the US dollar index and thus buy RMB or sell US dollars. This is the basic logic.

NBD: From the perspective of enterprises, what specific impacts does RMB appreciation have? How can export companies better avoid risks arising from exchange rate fluctuations?

Xiang Songzuo: Clearly, RMB appreciation benefits import companies and individuals planning to purchase property or invest overseas, as they need to convert RMB into US dollars. However, it is unfavorable for export companies.

For example, many export companies in the Greater Bay Area, the Pearl River Delta, and the Yangtze River Delta manage exchange rate risks by signing relatively long-term contracts with suppliers or customers. For instance, they may agree to settle transactions at a fixed rate of 1 USD to 7 RMB over the next three years. In such cases, if the RMB depreciates in the future, the importer bears the risk; if the RMB appreciates, the exporter bears the risk. Once such long-term contracts are established, the risks are factored in and internalized in advance.

Essentially, these relatively long-term contracts transform a floating exchange rate into a "fixed exchange rate." Both parties make decisions and adjustments based on this "fixed rate," such as determining whether a transaction will be profitable at that exchange rate level. With a clear anchor, decision-making becomes more transparent and manageable; without it, businesses operate under constant uncertainty.

It should be emphasized that the collapse of the global monetary system in the 1970s, including the subsequent proliferation of floating exchange rates, bears significant responsibility on the United States. Under a floating exchange rate regime, the US has substantial room for manipulation—especially through Federal Reserve interest rate cuts, which lead to an increase in the money supply. The risks are then transferred to other economies, while the US itself avoids bearing them. This is the essence of dollar hegemony. Since the currencies of various economies are directly or indirectly pegged to the US dollar, the US does not need to worry about exchange rate volatility. Moreover, US companies primarily conduct transactions with foreign companies in US dollars, so they are also insulated from exchange rate risks.

NBD: With the RMB continuing to strengthen, what are your expectations for the future?

Xiang Songzuo: China's exchange rate mechanism is a managed floating system. Therefore, rapid and unilateral appreciation or depreciation is unlikely to occur. However, given that it is a floating system, moderate appreciation or depreciation is possible.

Looking at a basket of currencies over the course of 2025, the RMB exchange rate has remained largely stable. While the RMB depreciated against the euro and the British pound, it appreciated against the US dollar and the Japanese yen. For 2026, the basic expectations are: first, there will be no rapid and unilateral appreciation; second, the more likely scenario is two-way, modest fluctuations; third, rapid and unilateral appreciation would be detrimental to the overall Chinese economy.

Therefore, expectations of sustained and significant RMB appreciation should be dismissed. The reason is simple: rapid and unilateral RMB appreciation is not in China's economic interest, and the People's Bank of China and the State Administration of Foreign Exchange have the tools to maintain stability in the foreign exchange market.

Furthermore, it is important to emphasize that when observing the RMB exchange rate, one should consider a trade-weighted basket of currencies, rather than focusing solely on the RMB/USD rate.

The Ideal State of Economic Operation Is to Adopt a Fixed Exchange Rate

NBD: Regarding exchange rates, some mainstream views hold that they reflect the valuation of a country's economic strength. What is your view on this?

Xiang Songzuo: The belief that exchange rates represent a country's economic strength is a misunderstanding.

When discussing exchange rates, it is essential to first clarify a fundamental point: they serve as an anchor for an economic system, and the determination of this anchor is often deeply rooted in historical context.

For example, in 1983, the Hong Kong dollar was pegged to the US dollar at a rate of 7.8:1. Why this specific value? The Hong Kong dollar was previously pegged to the British pound. In the 1970s, the pound experienced significant volatility, leading to instability in the Hong Kong dollar. The Hong Kong government then decided to peg it to the US dollar. At the time, the black market exchange rate between the Hong Kong dollar and the US dollar was 7.8, so this rate was adopted. Over 40 years have passed since then, during which the economies of Hong Kong and the US have undergone significant changes, yet the exchange rate anchor has remained around 7.8 with little deviation.

Thus, exchange rates are not a valuation of an economic system. In the long run, the level or movement of an exchange rate does not reflect the strength or weakness of an economy.

The Japanese yen also illustrates this point well. After World War II, Japan implemented monetary reform and adopted a fixed exchange rate, setting the USD/JPY rate at 360. This rate remained unchanged until the early 1970s, yet it did not prevent Japan's rapid economic growth. In fact, when Japan's economy later weakened, the yen appreciated. More recently, over the past decade, Japan's economy has shown overall improvement, yet the yen has depreciated from below 76 to over 100.

Therefore, we cannot assume that exchange rate levels reflect the strength of an economic system. Even under a floating exchange rate regime, exchange rate fluctuations do not have a clear or direct relationship with real economic performance. Years ago, I wrote that in the era of floating exchange rates, exchange rate volatility does not indicate the strength of the real economy but rather acts as noise. Currency appreciation does not necessarily mean a strong economy, and depreciation does not necessarily mean a weak one.

Hence, our understanding of exchange rates needs to be updated. Just as the saying "the stock market is a barometer of the economy" is a popular misconception, the idea that "exchange rate fluctuations reflect changes in the economic strength of two countries" is also misleading.

NBD: What, in your view, is the essence of exchange rates?

Xiang Songzuo: As mentioned earlier, fundamentally, an exchange rate is an anchor for an economic system.

Throughout most of human history, exchange rates between economies were actually fixed. Generally speaking, before 1950, major economies maintained fixed exchange rates for extended periods. For example, the exchange rate between the US dollar and the British pound remained fixed from 1820 to 1914—nearly a century—during which people had no concerns about exchange rate risk. If an economy grew steadily, this was reflected in rising incomes for its residents.

Why do people today care so much about exchange rates? It is because, since the 20th century, with the emergence of fiat currency, floating exchange rate systems have come into play.

This raises a question: under a floating system, how were initial exchange rate values determined?

In most cases, they were subjectively set—for example, when a country launched exchange rate reform, a rate was simply established, rather than being the result of complex and precise calculations.

Second, the determination of an exchange rate is essentially a choice made by the monetary authority. Once a rate is chosen, other economic indicators automatically adjust around it. This is precisely why the exchange rate functions as an anchor.

That is, at a given point in time, an economy can selectively determine a certain exchange rate value. Once set, the market continues to fluctuate and adjust over a period of time. Gradually, the market becomes accustomed to this level, and imports, exports, wages, and prices adapt accordingly. The economy then moves toward a new dynamic equilibrium.

A fundamental theory that cannot be overlooked when understanding exchange rates is the Mundellian "impossible trinity": no economy can simultaneously achieve exchange rate stability, free capital mobility, and an independent monetary policy. The Asian financial crisis occurred precisely because these countries allowed free capital movement and sought to maintain independent monetary policies, which required sacrificing exchange rate stability. However, before the crisis, they insisted on maintaining exchange rate stability, leading to massive capital outflows. As foreign reserves dwindled, they were forced to abandon the fixed rate, resulting in sharp depreciation and severe market turmoil. The Asian financial crisis was, in essence, a real-world manifestation of the "impossible trinity" theory.

As an anchor for an economic system, an exchange rate can be chosen to float or to be fixed. Under a fixed exchange rate, if the economy grows, wages and asset prices adjust upward accordingly; if the economy weakens, they adjust downward.

I would like to emphasize that, from the perspective of human history, the ideal state for economies is to adopt a fixed exchange rate. Once the exchange rate is fixed, economic indicators are no longer affected by exchange rate fluctuations but instead adjust based on factors such as technological innovation and productivity growth. In this scenario, economic indicators can more accurately reflect the true state of the economy without interference from exchange rate volatility. The notion that currency appreciation automatically raises household income levels is, in fact, wishful thinking.

In reality, since the 1970s, as the world has shifted toward floating exchange rates, this has not been progress from the perspective of monetary theory. Fundamentally, floating exchange rates introduce excessive noise into economic operations, particularly creating unnecessary risks for businesses.

Since the collapse of the international monetary system in the 1970s, exchange rates have, in practice, become easy tools for manipulation.

For this reason, I have long advocated that the ideal state of economic operation is to adopt a fixed exchange rate.

Becoming a Major International Currency Depends on Widespread Use in Global Markets

NBD: How do you assess the current credibility of the US dollar and its future prospects?

Xiang Songzuo: I teach a course titled "Dollar Hegemony and the Future of Money." In summary: first, in the foreseeable future, the US dollar will remain the world's primary currency, as no currency currently exists that can rival it.

Second, the foundation of dollar hegemony lies in the comprehensive strength of the United States, not just a single factor. Specifically, US comprehensive national strength is evident in multiple areas, including economic scale, technological innovation, the size of capital markets, and the level of financial regulation—all of which lead globally.

Some often claim that dollar hegemony stems from military power, but this is not the essence. The core lies in technological and economic strength. Third, a common misconception is that the strength of a currency can be judged by its exchange rate level and fluctuations. This is highly misleading. The most important criterion for assessing a currency's strength is the global market's demand for it.

NBD: What suggestions do you have for further advancing the internationalization of the RMB?

Xiang Songzuo: International markets use a currency primarily because: first, it facilitates trade invoicing and settlement. In recent years, as China's manufacturing sector has grown stronger and trade volumes have increased, the use of RMB for settlement has also risen steadily, marking significant progress in this area. Second, beyond trade settlement, people wish to use the currency for financial asset investment. China has also made some progress in this regard. How financial markets can be better opened and how China's capital markets can be developed into truly global markets remain major challenges.

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(Source: National Business Daily)