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Chapter 17 Exchange Rate: Leveraging the Pivot of Global Trade (3)
unexpected exchange rate fluctuations

On January 1999, 1, the euro, carrying many hopes, debuted at an exchange rate of 1 US dollars per euro.Despite initial expectations that the euro would emerge as a strong currency in world markets, its performance has not been satisfactory. In October 1.18, the euro depreciated by 2000%, reaching a low of 10 US dollars per euro, and only recovered in early 30. 0.83 USD/EUR level.The euro weakened in the first two years and rebounded in the third and fourth, with obvious fluctuations, similar to the euro.

This sharp fluctuation of the exchange rate is due to the meaning of many people.About 30 years ago, most economists believed that free market-determined exchange rates would not fluctuate very much.But it turns out they were wrong.We can find that the exchange rate fluctuations of the US dollar between 1980 and 2002 were quite severe.

Any sharp fluctuations in the exchange rate of any currency are not good for the country.Maintaining a stable exchange rate is the goal of government policy.So it is necessary to find out the reasons for the sharp fluctuations in exchange rates?Many economic analysts largely fail to notice that changes in real interest rates are an important factor in exchange rate fluctuations.If domestic real interest rates fall relative to foreign countries, the domestic currency depreciates.In fact, that's exactly what happened with the euro.When the euro was born, the European economy was slowly recovering from recession, and both nominal and real interest rates were falling.On the contrary, in 1999 and 2000, the US economy grew very rapidly, greatly exceeding the level of Europe.Previous analysis has shown that low real interest rates in Europe relative to the United States pull down the value of the euro.

In the spring of 2001, the U.S. economy grew slowly and gradually entered recession, and the above phenomenon was reversed.Growth rates in the US were slightly lower than in Europe, so the relative levels of real and nominal interest rates fell, leading to a recovery in the value of the euro.

On the other hand, expectations can also affect exchange rate fluctuations to a greater extent.This includes many aspects.Since the expected appreciation of the domestic currency affects the expected rate of return on foreign deposits, expectations about the price level, inflation rate, trade barriers, production capacity, import demand, export demand, and money supply play an important role in determining the exchange rate .A change in expectations for any one variable immediately affects the expected return on domestic deposits, which in turn affects the exchange rate.Changes in expectations of these variables are actually commonplace in economic operations, so exchange rate fluctuations are quite natural.In addition, as mentioned above, when the money supply increases, there will be overshooting of the exchange rate.Exchange rate overshooting is another reason for frequent exchange rate fluctuations.

Early economists' analyzes of exchange rate behavior focused primarily on commodity markets rather than asset markets, so they failed to show that changes in expectations were an important cause of exchange rate movements, and thus failed to predict large exchange rate fluctuations.Modern financial analysis methods emphasize that the foreign exchange market, like other asset markets, is full of expectations for the future.The foreign exchange market is the same as the asset market such as the stock market.Price levels fluctuate wildly, and exchange rates naturally fluctuate along with them, but the level at which they fluctuate is highly unpredictable.

As the saying goes, good and bad come and go, good and bad depend on each other.Exchange rate fluctuation itself is a reflection of the operation of the economy, and it can even be said to be a result.Exchange rate fluctuations provide a complex indicator that reflects an economy's industrial structure, growth pattern, production efficiency, trade status, and many other information.Observe this indicator to judge the status of economic development, and determine the development strategy and regulation policy is the fundamental task.And all these analyzes have a very important premise, that is, the exchange rate market must be effective, and the exchange rate can float freely.At the same time, the whole process must be in an environment far from speculation.

Establish a relatively transparent environment, protect the market, let the market play a role, improve the efficiency of the market; increase the floating range of the exchange rate, and move towards free floating.In this way, a relatively stable and flexible exchange rate floating range can be maintained to ensure the smooth operation of the economy.

Intervention in the foreign exchange market: what is the intention of the government?In recent years, "foreign exchange intervention" has become a familiar term, and we often hear another term "exchange rate manipulation", but the latter implies the accusation of "lowering the exchange rate to gain illegitimate profits".In fact, joint actions of central banks in the foreign exchange market are rare.Although since 2008, there have been G7 joint interventions in the foreign exchange market to support the U.S. dollar, but experts believe that from the perspective of economic fundamentals, with the stabilization of the U.S. financial market and the excessive depreciation of the U.S. dollar will be corrected by the market mechanism, the central bank will actually intervene in the market The possibility is not great.

This is because, first, in fact, after the outbreak of the financial crisis, the exchange rates of various countries have not deviated from the basic economic conditions of each country. Behind the record highs of currencies such as the euro, the Australian dollar, and the British pound, there are economic overheating, strong export demand, and investment. The strong support of factors such as strong consumption, the continued depreciation of the US dollar is also affected by its twin deficits and the "substandard goods crisis".Second, the temporary main exchange rate level is acceptable to all parties, because unilateral intervention is not easy, and it is difficult to achieve significant results without joint intervention, and the process of deciding whether to join forces is a game stage.The third is that the adjustment mechanism of the market itself is still effective.The euro stopped at $1.60, and the dollar gradually stabilized.After the financial industry experienced the impact of the "subprime mortgage crisis", it gradually stabilized and the stock market rebounded. The G7's FX intervention is likely to say more than it does, with experts calling it a "true lie" at best.

The so-called intervention in the foreign exchange market refers to any foreign exchange transactions by the monetary authority in the foreign exchange market to affect the exchange rate behavior of the domestic currency.The way can be the use of foreign exchange reserves, inter-central bank transfers, or official lending.

In the early 80s, the exchange rate of the U.S. dollar against the currencies of all European countries was on the rise, and whether the industrial countries should intervene in the foreign exchange market or not, the Versailles summit meeting of industrial countries in June 1982 decided to set up a "council" composed of official economists. Foreign Exchange Intervention Working Group", which specializes in foreign exchange market intervention. In 6, the group published the "Working Group Report" (also known as the "Jergensen Report"), in which the narrow definition of intervention in the foreign exchange market is: "Any foreign exchange transaction by the monetary authorities in the foreign exchange market to affect the value of the domestic currency. "Exchange rate" through the use of foreign exchange reserves, transfers between central banks, or official lending.In fact, in order to truly understand the essence and effect of the central bank's intervention in the foreign exchange market, it is also necessary to understand the impact of this intervention on the country's currency supply and policies.Therefore, in terms of the means by which the central bank intervenes in the foreign exchange market, it can be divided into interventions that do not change the existing monetary policy (also known as "disinfected intervention") and interventions that change the existing monetary policy (also known as "non-disinfected intervention").The so-called intervention without changing the policy means that the central bank believes that the sharp fluctuation of foreign exchange price or the deviation from the long-term equilibrium is a short-term phenomenon, and hopes to change the existing foreign exchange price without changing the existing money supply.In other words, it is generally believed that changes in interest rates are the key to changes in exchange rates, and central banks try to change the exchange rate of their currencies without changing domestic interest rates.

Generally speaking, successful foreign exchange intervention needs to meet the following conditions: first, the short-term financial market turmoil causes violent exchange rate fluctuations, and this short-term shock is not sustainable; second, the exchange rate deviates from the equilibrium level for a long time, which is In the real economy, it can be reflected in long-term global trade imbalances; third, due to the large daily trading volume in the foreign exchange market, successful foreign exchange intervention often requires the coordination and joint intervention of central banks of various countries.Under the above conditions, market intervention is often accompanied by a trend reversal of the exchange rate, and by influencing the expectations of other market participants, it accelerates the convergence of the exchange rate to the equilibrium level.Conversely, if the foreign exchange market intervention is only understood by market participants as increasing "noise", the short-term effect will be limited, and the final intervention will be just a slap in the face.

Capital control: the "golden cudgel" to stabilize the exchange rate

Since the boom in China's stock market and property market in 2006, all walks of life have begun to realize that there is a large-scale influx of hot money.The National Development and Reform Commission then asked all localities to strengthen and standardize the management of foreign investment projects to prevent the abnormal inflow of foreign exchange funds from bringing potential risks to the healthy development of China's economy and the balance of payments.

Preventing "fake foreign investment" is not a new problem.However, against the backdrop of unprecedented heated debates in the entire economic circle about hot money, the National Development and Reform Commission emphasized the regulation of "FDI" (foreign direct investment) and the prevention of abnormal inflows of foreign exchange funds, aiming at hot money.Hot money is a short-term speculative fund that flows rapidly in the international financial market.The concept and energy of hot money are both familiar and unfamiliar to people.When many people talk about hot money, they must recall the various manifestations of hot money during the Asian financial crisis.In the impression of many people, hot money is a deceitful capital demon.

The document of the National Development and Reform Commission is to regulate the inflow and outflow of foreign exchange funds under trade in goods, mainly to prevent the entry of hot money.This is a typical method of capital control.

The control of hot money belongs to the category of capital control.The hotline is also called hot money or speculative short-term capital, which is short-term speculative funds that flow rapidly in the international financial market only for the pursuit of the highest return with the lowest risk.Hot money has the characteristics of "four highs": high yield and risk; high information and sensitivity; high liquidity and short-term; high fictitious and speculative investment.The rapid inflow and outflow of hot money will undoubtedly have a strong impact on the domestic financial market, so the control of hot money is usually an important task of financial regulatory authorities.

Capital control mainly includes the control of capital outflow and capital inflow.

The reason why capital outflows are controlled is because capital outflows can cause financial turmoil in emerging market countries, and capital outflows will force the country's currency to depreciate.That's why politicians in some emerging-market countries find capital controls particularly attractive.For example, former Malaysian Prime Minister Mahathir Mohamad initiated capital controls in 1998 to limit capital outflows following the East Asian crisis.

While these controls sound great, there are several drawbacks.Controls on capital outflows are nearly ineffective during crises because the private sector has the flexibility to circumvent them and move money out of the country with little effort during times of market turmoil.Moreover, limited control may increase capital flight, which is the nature of capital seeking profit.

Many economists therefore oppose capital outflow controls, but support capital inflow controls.If speculative capital can't get in, then they won't rush in and out, causing chaos and crisis.Economists believe that capital inflows can lead to loan expansion and excessive risk-taking by banks, which can help trigger financial crises.

However, controls on capital inflows can also be difficult in that they may prevent funds for productive investment from entering a country.While such controls can limit the factor of loan expansion through capital flows, over time firms will find ways to evade the controls, which can lead to misallocation of resources.In practice, controls on both capital outflows and capital inflows can lead to corruption.

Of course, there are successful examples that capital inflows are less likely to cause market disruption as long as banking regulation is strengthened.For emerging markets, capital management plays a huge role in maintaining market stability and reducing risks.

How China's Foreign Trade 'Myth' Affects Exchange Rates

2006 was an unusual year for the Chinese economy.On the one hand, China's economy continues to maintain strong growth. It is estimated that China's GDP growth rate in 2006 reached 10.7%, and the per capita GDP has exceeded 2000 US dollars, both of which are record highs.According to the global trade report released by the WTO, in 2006 the total import and export volume of global commodities, China ranked third in the world after the United States and Germany.There are various signs that the Chinese economy is becoming one of the main driving forces of global economic growth with its strong growth force.The United States is deeply aware of the enormous pressure brought about by China's economic growth. In 2006, the Sino-US trade surplus reached 1442.6 billion US dollars, the highest in history.Therefore, the United States put economic pressure on China and forced the renminbi to appreciate on the grounds that Chinese workers robbed American workers of their jobs and caused losses due to the huge trade surplus.In order to adjust and ease the trade friction between China and the United States, China and the United States held the first Sino-US Strategic Economic Dialogue in December 2006, and RMB appreciation became the focus of this dialogue.Paulson, former secretary of the U.S. Department of the Treasury, said that a more flexible RMB exchange rate will help China allocate funds more effectively, and "the whole world will not tolerate China adjusting the RMB exchange rate at such a slow pace."

It is said that as early as 2006, the U.S. Senate passed a resolution, but it did not vote.Its content is that if the RMB does not appreciate significantly in October 2006, all products from China will be subject to a 10% tariff.

From 2006 onwards, the rate of appreciation of the renminbi accelerated.This is because on the one hand, the U.S. economic engine has slowed down significantly, and the U.S. dollar in the international exchange market has weakened across the board, which has triggered a continuous rise in the RMB exchange rate.On the other hand, China's foreign exchange reserves exceeded the US$2006 trillion mark in October 10, and the cumulative trade surplus in the first 1 months has reached US$10 billion. This is the deepest factor for the appreciation of the renminbi.

In international financial operations, a country's balance of payments will lead to fluctuations in its currency exchange rate.The balance of payments is a summary of all the foreign economic and financial relations of the residents of a country.A country's balance of payments reflects the country's international economic status, and also affects the country's macro- and micro-economic operations.In the final analysis, the impact of the balance of payments is the impact of the supply and demand of foreign exchange on the exchange rate.

Foreign exchange receipts arising from an economic transaction (such as an export) or a capital transaction (such as foreign investment in the country).Since foreign exchange is usually not freely circulated in the domestic market, foreign currency needs to be converted into domestic currency before it can be put into domestic circulation.This forms the foreign exchange supply in the foreign exchange market.Foreign exchange expenditures are incurred due to an economic transaction (eg import) or capital transaction (investment abroad).Because the domestic currency must be converted into foreign currency to meet their respective economic needs, there is a demand for foreign exchange in the foreign exchange market.

Combining these transactions and recording them all in the balance of payments statistics constitutes a country's foreign exchange balance.

How does the balance of payments affect exchange rates?

If foreign exchange income exceeds expenditure, the supply of foreign exchange increases; if foreign exchange expenditure exceeds income, the demand for foreign exchange increases.When the supply of foreign exchange increases, when the demand remains unchanged, the price of foreign exchange will directly decrease, and the value of the local currency will rise accordingly; when the demand for foreign exchange increases, the price of foreign exchange will directly increase under the condition of constant supply As the currency rises, the value of the local currency falls accordingly.

(End of this chapter)