For much of the last half-century, the study of global exchange rates has been treated as a branch of physics. In the hallowed halls of neoclassical economics, there is a belief in a “natural” state of things, an equilibrium where trade balances and productivity levels act as gravity, pulling currencies back toward their fundamental value. If a country runs a persistent trade surplus, its currency should rise; if its factories become more efficient than its neighbors, its purchasing power should follow.
Yet as we look at the world in January 2026, this elegant clockwork mechanism appears to have broken down. The U.S. dollar, despite decades of eye-watering trade deficits, spent much of the past year defying gravity before its recent 10 percent slide. Meanwhile, the Chinese renminbi has spent nearly four years in a state of “internal depreciation,” with its real effective exchange rate falling by roughly 16-20 percent since 2022. This occurred even as Chinese electric vehicles and high-end electronics flooded global markets, a clear sign of the productivity gains that, in a neoclassical world, should have sent the currency soaring.
The disconnect suggests that we are looking through the wrong lens. Although the real economy of ships and factories still matters, it is increasingly a secondary player to the ghost in the machine: the global financial system. To understand why the world’s most important currencies are moving as they do, one must look past the trade ledgers and into the volatile world of capital flows and financial cycles.
The scale of the shift is staggering. According to the latest Bank for International Settlements data, daily foreign exchange turnover has surged to roughly $9.6 trillion. This figure is roughly 70 times the volume of global trade. In such an environment, the exchange rate is less a reflection of the price of goods and more a reflection of the price of assets. It is a barometer of “animal spirits,” to use the Keynesian term: a measure of where global investors want to park their capital and where they fear to leave it.
This brings us to the core of the (post-)Keynesian critique. Unlike the neoclassical view, which assumes that markets are rational and self-correcting, the Keynesian perspective recognizes that expectations can become self-fulfilling prophecies. In a world of deep financialization, capital flows do not just reflect reality; they create it. If investors expect a currency to depreciate, they flee, causing the very depreciation they feared, regardless of whether the underlying trade balance is in surplus or deficit.
The experience of China in 2025 offers a vivid illustration. For years, the Balassa-Samuelson hypothesis—a staple of neoclassical theory—predicted that China’s rapid industrial upgrading would lead to a stronger renminbi. But the reality of the financial cycle proved more powerful. As China’s property sector underwent a painful deleveraging, with even state-backed giants like Vanke forced into debt restructuring this winter, the domestic credit environment tightened.
In a financial downswing, the usual rules of trade-driven appreciation are suspended. Low domestic demand and falling property prices created a deflationary drag that the “real” economy, no matter how productive, could not overcome. The resulting lack of appetite for renminbi-denominated assets meant that capital stayed on the sidelines, keeping the currency weak despite record-breaking trade surpluses that officially hit $1.2 trillion for the 2025 calendar year. Fresh customs data released six days ago shows that December 2025 exports surged by 6.6 percent, far outstripping analyst expectations.
As the Fifteenth Five-Year Plan looms for 2026, however, there are signs that China’s financial cycle is nearing its floor. In recent weeks, the renminbi has reached a 14-month high against a softening dollar. This shift is not driven by a sudden change in the trade balance, which has remained robust for years, but by a recalibration of financial expectations. With U.S. interest rates finally beginning to moderate and China’s domestic bond market showing signs of stabilization, global capital is once again looking for an entry point.
A case in point is the boom in “dim sum” bonds, the yuan-denominated debt issued in Hong Kong that hit record highs this month. Major tech players like JD.com are weighing massive debut offerings to lock in cheap funding. It represents a vote of confidence in currency stability that has little to do with the price of Chinese steel and everything to do with the search for yield in a post-tightening world.
The broader lesson for policymakers and investors is that the era of monetary neutrality is over. Finance is not a passive servant of the real economy; it is often its master. The neoclassical insistence on Purchasing Power Parity as a long-term anchor for exchange rates is increasingly a nostalgic fantasy. In reality, exchange rates have deviated from these theoretical equilibriums for decades, driven by the tides of global liquidity and the shifting moods of the world’s bond vigilantes.
In 2026, the global financial architecture is undergoing a profound recalibration. The dollar remains the world’s anchor, on one side of 89 percent of all transactions, but its structural advantage is being tested by a world that is no longer content to rely on a single, volatile source of liquidity. China’s efforts to deepen financial cooperation with hubs like Singapore and the growing use of the renminbi as a reserve asset are part of a broader attempt to build a financial cycle that is less dependent on the whims of the U.S. Federal Reserve.
For those trying to predict the next big move in the currency markets, the advice is clear: stop looking at the shipping manifests and start looking at the balance sheets. In the twenty-first century, the exchange rate is an asset price, governed by the laws of finance rather than the laws of trade. To ignore the financial cycle is to risk being blindsided by the movements of the global economy.