China’s merchandise trade surplus surged by $111.7 billion in November, bringing the total for the first 11 months of 2025 to $1.08 trillion a 22.1% increase compared to the same period last year, according to official data. While Western media describe the surplus as “remarkable,” concerns are rising that it may be “unsustainable,” with many pointing to a potentially undervalued renminbi (RMB).
Economists are increasingly calling on Beijing to allow a gradual appreciation of the RMB over the next five years. A stronger currency could boost imports and ease pressure on global competitors in Europe, the US, and elsewhere, who have been losing market share to Chinese exports.
Rethinking Exchange-Rate Evaluation
The debate over whether the RMB is over- or undervalued has reignited. Traditional neoclassical models, like purchasing power parity (PPP) and the Balassa-Samuelson hypothesis, suggest that the RMB may diverge from its “equilibrium value.” These models focus on real-economy fundamentals—productivity, prices, and the current account—while treating capital flows and foreign-exchange trading as short-term reactions rather than long-term drivers of currency trends.
However, critics argue that these models are increasingly misaligned with today’s highly financialised global economy. Annual foreign-exchange trading now far exceeds global trade in goods and services, meaning frameworks that focus solely on trade balances may miss key market realities.
(Post-)Keynesian approaches offer a different perspective. They emphasize that capital flows, financial cycles, and shifts in investor expectations play a central role in determining exchange rates. While the real economy remains important, financial forces can influence both short-term fluctuations and long-term trends. Under this view, PPP-based exchange rates may never actually materialize.
Reconciling the Two Approaches
Economists stress that neoclassical and (post-)Keynesian perspectives are not mutually exclusive. However, relying solely on neoclassical models during periods of financial volatility can lead to misjudgments. A comprehensive analysis must consider both real-economy fundamentals and financial dynamics, with the latter often decisive.
The RMB illustrates this complexity. Factoring in China’s position within the global financial cycle makes recent currency movements appear less anomalous. Once financial-cycle dynamics are considered, the RMB may not significantly deviate from any plausible equilibrium rate—assuming such a benchmark exists.
Evidence from History and Data
Neoclassical theory predicts that persistent trade deficits or surpluses will self-correct through exchange-rate adjustments. Yet the real world often contradicts this. The US has maintained large trade deficits for decades without a long-term dollar decline. Similarly, China’s RMB movements have not consistently aligned with current-account trends, even under capital controls.
BIS data underscore the dominance of financial forces. In 2022, daily global FX trading reached $7.5 trillion, far exceeding annual global trade of roughly $32 trillion. In such an environment, exchange rates reflect financial transactions, capital flows, and market expectations more than trade fundamentals.
China’s post-2005 experience confirms this. After reforms, the RMB appreciated nominally alongside rising domestic prices—a trend difficult to reconcile with PPP but consistent with financial-cycle dynamics, where capital inflows and credit expansion reinforce each other. More recently, despite productivity gains, the RMB’s real effective exchange rate depreciated by around 16% between January 2022 and October 2025, reflecting a downswing in the financial cycle, weaker domestic demand, and reduced incentives for holding RMB assets.
Looking Ahead
Signs suggest the financial-cycle adjustment may be nearing its end. As conditions stabilize, capital allocation into RMB assets is increasing, contributing to recent currency movements. Analysts argue that claims of significant RMB undervaluation based solely on traditional models may be overstated.
The broader lesson is clear: exchange-rate analysis must evolve alongside the global economy. In a finance-dominated world, ignoring capital flows, financial cycles, and expectations risks misreading both the causes and consequences of currency movements.
