Faced with the world's greatest changes unseen in a century and the impact of the COVID-19 epidemic, the international and domestic situation is complicated: the global economy is facing a deep recession; economic growth 's external environment continues to deteriorate; Sino-US frictions have escalated; the anti-globalization trend and the threat of Sino-US decoupling have overlapped; and the development of the export-oriented economy has been hindered. The "14th Five-Year Plan" outline proposes: "Smooth domestic circulation and promote domestic and international dual circulation ". In the current international and domestic environment, what will be the future trend of the RMB exchange rate and the world's major currencies? What financial policies should China adopt to ensure stable and healthy economic development? With these questions in mind, a reporter from China Fund News exclusively interviewed Guan Tao, an expert in the field of RMB exchange rate research, member of the first China Foreign Exchange Market Steering Committee, and global chief economist of BOC Securities .
The RMB has a promising future and the exchange rate formation mechanism is increasingly market-oriented.
"China Fund News": Recently, the RMB has been depreciating against the US dollar. What is the main reason? Is this a short-term fluctuation or a long-term trend? What are the main factors affecting the exchange rate of and in the next 2-3 years?
Guan Tao: This year’s adjustment of the RMB against the US dollar is the result of a combination of internal and external factors. One of the external factors is the divergence of monetary policies between China and the United States, and the convergence or even inversion of interest rate differentials between China and the United States. As the divergence of monetary policies between China and the United States expands, the negative interest rate differential between China and the United States will continue to expand. Secondly, driven by interest rate differentials and risk aversion, the US dollar index strengthened. The U.S. dollar recently hit a 20-year high, and the U.S. dollar index has been fluctuating repeatedly at the 110-point level. It is generally believed that as long as the U.S. dollar index stands above 100 points, it means that the U.S. dollar is strong. The first wave of adjustments to the RMB exchange rate in this round happened to occur at the end of April 2022 when the U.S. dollar index stabilized above 100. Then there are the hedging capital operations triggered by the geopolitical incident at the beginning of the year. Internal factors are that the domestic epidemic has spread at multiple points, affecting economic recovery and export prospects.
Of course, everything has pros and cons. Due to the large adjustment of the RMB this year, if next year we can coordinate epidemic prevention and control and economic and social development more efficiently while the Fed continues to tighten and global economic growth slows down, make good use of our fiscal and monetary policy space, deepen reform and expand opening up, achieve reasonable economic growth, and maintain our leading position in economic recovery, this will create new attractions for foreign investment, and the RMB may once again embark on a wave of rising prices. Therefore, I believe that this year's RMB exchange rate adjustment is affected by short-term factors and is not a long-term trend.
In the future, the rise and fall of the RMB exchange rate will not depend on the strength of the US dollar, nor on the interest rate differential between China and the United States, but on the prospects of the Chinese economy. After we successfully convened the 20th National Congress, we made a series of strategic arrangements for the new journey of comprehensively building a modern socialist country. How we implement the spirit of the 20th National Congress, substantively promote high-quality economic development, and achieve steady economic growth is a key factor affecting future exchange rate trends. As long as we properly respond to geopolitical conflicts, find our own position amid changes unseen in a century, implement responsible fiscal and monetary policies, maintain reasonable economic growth, and keep the real purchasing power of the RMB stable, I am confident in the future trend of the RMB.
"China Fund News": Does the sharp fluctuation of the RMB exchange rate in recent years reflect the increasing flexibility of the RMB exchange rate and the increasingly mature exchange rate formation mechanism?
Guan Tao: Yes, in the first ten months of this year, the maximum amplitude of the central parity of the RMB exchange rate was 13.9%, and the maximum amplitude of the closing price was 15.8%, which was the largest since the exchange rate unification in 1994. This reflects the increasing marketization of the RMB exchange rate formation mechanism. Moreover, the increase in exchange rate flexibility will help to play a "shock absorber" role in absorbing internal and external shocks, thus ensuring the independence of domestic monetary policy. It will also help reduce reliance on capital and foreign exchange management methods, which will fundamentally boost the confidence of domestic and foreign investors.I attended an internal seminar a while ago, and some foreign investors said that judging from the fluctuations in the RMB exchange rate this year, the Chinese government's tolerance for RMB exchange rate fluctuations has significantly increased. Although the RMB has hit a new low in more than ten years so far, the Chinese government has not taken any new measures to restrict capital outflows, but has only introduced some macro-prudential and policies to encourage capital inflows. Therefore, if we want to expand financial opening and promote the internationalization of the RMB in an orderly manner, we must have a flexible exchange rate policy.
It’s time to launch RMB foreign exchange futures trading
"China Fund News": In July 2021, the "Opinions of the Central Committee of the Communist Party of China and the State Council on Supporting the High-level Reform and Opening Up of Pudong New Area to Create a Leading Area for Socialist Modernization Construction" proposed to study and explore the launch of pilot RMB foreign exchange futures trading in the China Foreign Exchange Trading Center and other places. You also mentioned in your book "The Logic of Exchange Rates" that it is time to launch RMB foreign exchange futures trading. The RMB exchange rate has fluctuated significantly recently. What is the positive significance of launching RMB foreign exchange futures trading? What risks should we pay attention to?
Guan Tao: There has always been a demand in the market for to hedge the risk of RMB exchange rate fluctuations. Therefore, there have already been RMB foreign exchange futures transactions in the international market, but futures without principal delivery . Launching a pilot program for RMB and foreign exchange futures trading and launching standardized RMB foreign exchange futures products will facilitate the participation of small and medium-sized enterprises and provide them with tools to hedge RMB exchange rate risks. From a regulatory perspective, the standardized floor trading is also convenient for supervision and monitoring. Now, no matter whether the RMB appreciates or depreciates, many transactions are completed in the offshore market. We have neither supervision nor data on the offshore foreign exchange market. We don’t know other people’s positions and prices, nor can we grasp their delivery time. This is very passive.
During the Southeast Asian financial crisis in 1998, the Thai baht fell. If the Thai government had known that many short positions in the Thai baht would be subject to physical delivery in a few days, and had persisted for a few more days, it might have been able to survive the disaster technically. When the Hong Kong dollar was under attack, the Hong Kong Monetary Authority knew the position of and in the Hong Kong dollar index, so it could counterattack in a planned, step-by-step and targeted manner. This year, the "major nickel mine owner" Tsingshan Holdings was forced into a short position of 2.2 million tons, which also suffered from the asymmetry of information in the market. Therefore, as cross-border transactions and use of RMB become more widespread and frequent, we should have an onshore under-exchange foreign exchange futures trading market under supervision.
Of course, everything has pros and cons. We must also pay attention to preventing risks. For example, if you use to trade on margin for foreign exchange futures trading, investors may lose all their money once their positions are liquidated; in the early stages of development, market liquidity may be poor and price manipulation is prone to occur; as well as how to open to foreign investment and how to prevent risks, etc. But I believe that there will be professionals who will improve the rules of trading and supervision based on their professional experience. In addition, overseas experience can also be learned.
Promoting the internationalization of the RMB requires starting from the inside out
"China Fund News": China is accelerating the construction of a new dual-circulation development pattern to cope with major changes unseen in a century. This means that while China's economy is based on itself, it must create a larger and smoother international circulation of RMB while seeking progress while maintaining stability. What suggestions do you have for the internationalization of the RMB?
Guan Tao: The just-concluded 20th National Congress of the Communist Party of China proposed to accelerate the construction of a new development pattern and strive to promote high-quality development. One of the important contents is to promote high-level opening up. Promoting the internationalization of the RMB in an orderly manner is an important component of high-level opening up. Regarding the internationalization of the RMB, the formulation of the 20th National Congress report is "orderly advancement", which is more positive than the "steady and prudent advancement" proposed by the Fifth Plenary Session of the 19th CPC Central Committee, which fully demonstrates the concept of open development. I believe that the next step to promote the internationalization of the RMB in an orderly manner must be from the inside out. It is recommended to start from the following aspects.
First, keep the economy running smoothly.This year, our country's economy is facing the "triple pressures" of shrinking demand, supply shocks, and weakening expectations, as well as the impact of the epidemic of the century and the evolution of changes in a century. Although the economy has recovered, its foundation is not solid. Next, we should make good use of normal fiscal and monetary policy space, deepen reforms, expand opening up, and strive to keep the economy operating within a reasonable range. Judging from domestic and foreign experience, a strong economy means a strong currency. For example, the internationalization level of the Japanese yen reached its peak in the 1980s and 1990s when the Japanese economy was highly prosperous. As Japan's asset bubble burst and it fell into long-term economic stagnation, the internationalization of the Japanese yen also experienced a major setback. Therefore, only high-quality economic development that emphasizes both “quantity” and “quality” can continuously enhance the attractiveness of RMB assets and promote the steady and long-term development of RMB internationalization.
Second, improve macroeconomic governance. The current dollar-based monetary system has its inherent flaws. Whether the United States launches or withdraws from quantitative easing, it will have a greater spillover impact on overseas markets. In addition, the United States abuses financial sanctions from time to time, causing great harm to the credit-based international monetary system. In the face of disturbances from short-term external factors, China has maintained normal fiscal and monetary policies, maintaining a stable real purchasing power of the RMB - our domestic prices have basically remained stable. Maintaining the stable real purchasing power of the RMB will help enhance the attractiveness of the RMB and will be a long-term benefit to the internationalization of the RMB. People's Bank of China Governor Yi Gang published a signed article titled "Building a Modern Central Bank System" in the "Guidance Reader for the Report of the 20th National Congress of the Communist Party of China" and clearly stated that "building a modern central bank system" and "maintaining normal monetary policy for as long as possible". Therefore, we should follow the deployment of the "14th Five-Year Plan", accelerate the construction of modern fiscal, taxation and financial systems, strictly abide by fiscal and monetary disciplines, and maintain the health of the economic and financial system, so that we can better enjoy the benefits of capital flows and exchange rate fluctuations.
Third, accelerate the development of financial markets. In addition to the opening of trade projects, RMB internationalization also opens financial projects. China has a deep, broad and liquid multi-level capital market which is very important for the internationalization of the RMB. In particular, we must have a complete government bond market - after all, government bonds are the anchor for pricing risk-free assets. The next step is to further integrate with international rules and strive to achieve institutional and open to the outside world. I think there is some potential in this area.
Fourth, promote the opening of capital accounts. For a country's currency to become an international currency, it must first maintain sufficient liquidity. In addition to building a financial market with depth, breadth and liquidity and lower transaction costs , what is very important is the free flow of capital across borders. At present, we have only achieved partial convertibility under the capital account, and there is still a certain gap between being fully convertible. Of course, we cannot internationalize for the sake of internationalization, nor open for the sake of opening up. We must still promote high-quality development and high-level opening up based on the objective needs of China's economic development. At that time, the Four Asian Tigers and some Southeast Asian countries developed an export-oriented economy, expanded trade opening, and created the Asian economic miracle. When the time was not yet ripe, they promoted financial opening too radically and engaged in competition for regional financial centers, which resulted in the Asian financial crisis. This is a lesson for us. China still needs to coordinate development and security, adhere to the two-wheel drive of reform and opening up, and continuously improve our risk response and crisis management capabilities in the process of opening up.
Fifth, improve the financial infrastructure . For example, the RMB cross-border payment system (CIPS) will be further improved to make cross-border RMB payments more convenient, safer and lower cost. The construction of offshore RMB centers should also be accelerated to make RMB a market that operates continuously 24 hours a day. We also need to strengthen the construction of some soft power.
Sixth, strive to cultivate market demand. One characteristic of the international monetary system is network effects and path dependence. The market has become accustomed to using traditional international currencies for transactions, which has resulted in economies of scale and significantly reduced the cost of using traditional currencies and transaction costs.The RMB is an emerging international currency. Although it has made great progress in recent years, its starting point is still low. According to a survey by the Bank for International Settlements (BIS), the RMB's share of global foreign exchange market transactions has expanded from 4.3% in 2019 to 7% in 2022, and its ranking has risen from 8th to 5th in 2019, but there is still a huge gap with the top four; the U.S. dollar's share has remained stable at 88%. This aspect cannot be solely driven by policies. Chinese enterprises and financial institutions need to take the initiative to cultivate this market and tap its potential. Currently, in our cross-border trade settlement , the proportion of RMB settlement is still at a low level of less than 20%. This reflects to a certain extent that our companies have a low voice in international trade . Therefore, we should change the way of foreign trade development, from winning by quantity to winning by quality, and improve non-price competitiveness. There is also a long way to go in this regard.
There are flaws in the US dollar standard currency system
Be wary of black swans or gray rhinos next year
"China Fund News": The world has suffered from the US dollar hegemony for a long time. Since the early 1970s, the U.S. dollar has experienced three rounds of super appreciation cycles. The first round of the U.S. dollar super cycle caused and Latin America to fall into a debt crisis. The second round of the U.S. dollar super cycle triggered the Asian financial crisis. The current third round of the U.S. dollar super cycle is deeply impacting Europe, Japan and many developing countries. Will the US dollar fall from its pedestal?
Guan Tao: In the 1970s, with the collapse of the Bretton Woods system , the US dollar was decoupled from gold, gold was demonetized, and the international monetary system transformed from a gold exchange standard to a US dollar-based credit system. The current international monetary system has its inherent flaws, that is, it is difficult for U.S. economic policy to take into account the balance of the domestic and foreign economies at the same time. While the U.S. dollar is still the main or even central currency (also known as the key currency) in the world, the Federal Reserve's monetary policy mainly focuses on domestic priorities. It determines the tightening of monetary policy based on domestic economic growth, price stability, employment growth and financial stability in the United States. Whether it launches or exits quantitative easing, it will have a large spillover impact on overseas markets.
Since the outbreak of the subprime mortgage crisis in 2008, everyone has begun to reflect on the irrationality of the U.S. dollar-based international monetary system. But it is very regrettable that in the past ten years or so, the changes in the international monetary system have been lackluster. It is still a superpower and many strong structures, because there is no other choice.
Recently, in order to control domestic inflation, the United States has successively raised interest rates sharply, unable to take into account the siphoning effect of the strong dollar cycle on global capital. According to statistics from the U.S. Department of the Treasury, the cumulative net inflow of international capital into the United States in the first eight months of this year reached US$1.15 trillion, an increase of 44% year-on-year, exceeding the total last year and setting a new high since data were available for the same period in 1978. Driven by interest rate differentials and risk aversion, international capital is accelerating its return to the United States.
This wave of strong US dollar has had a huge impact on emerging market countries. The International Monetary Fund predicts that 30% of emerging market countries and 60% of low-income countries have already been or are approaching a debt crisis. A strong dollar has a greater impact on developed economies. The broad dollar index compiled by the Federal Reserve rose 10% in the first ten months of this year. Among them, the currencies of developed economies rose by 14%, while the currencies of emerging economies only rose by 8%. Both the pound and the yen fell by 20 to 30 percent.
Although there are many dissatisfaction with the US dollar-based international monetary system, the international community has not found a better alternative so far. China only needs to do its own thing in a down-to-earth manner and not think about who will challenge and replace whom in the internationalization of the RMB? The internationalization of the RMB should be a natural and natural process, and should be steadily advanced in accordance with the objective needs of China's economic development.
The international monetary system is divided into three levels: the central currency is the US dollar, the currencies of other developed countries such as the euro, pound, and yen are sub-central currencies, and the currencies of other countries are peripheral currencies. The short-term goal of RMB internationalization should be to develop from a peripheral currency to a sub-central currency.
"China Fund News": Are developed countries such as Europe and Japan currently facing greater financial risks ?
Guan Tao: Usually, open economies have a " trilemma ", that is, exchange rate stability, independent monetary policy, and free capital flow cannot be achieved at the same time. What Europe, the United Kingdom and Japan are facing today is not a "triple paradox" but a "dual paradox" - that is, with free flow of capital, it is difficult for monetary policy to be completely independent regardless of whether the exchange rate is fixed or floating.
The European Central Bank stepped out of the eight-year-long era of negative interest rates with a one-time 50 basis point interest rate hike in July. European Central Bank President Lagarde made it clear that the weakness of the euro is an important consideration for the ECB to raise interest rates - because the depreciation of the euro and the increase in commodity prices have intensified the import inflationary pressure in the euro zone.
Japan Although both CPI and core CPI are only 3%, due to the continued depreciation of the yen, the market is betting that the Bank of Japan will eventually give up control of the Japanese bond yield curve, and then the Japanese bond yield will soar, which may lead to a collapse of Japanese bonds, which will cause a huge financial impact. At present, the Japanese government's debt ratio is over 200%. The surge in Japanese bond yields will increase the Japanese government's debt repayment burden, which in turn will lead to unsustainable government debt. Of course, it still seems to be a small probability event at present, but we will wait and see whether this game can continue to be played.
Many black swans or gray rhinos may appear next year. We must be careful, act cautiously and cherish them.
Editor: Wang Shidan | Reviewer: Li Zhen | Director: Wan Junwei
(Source: China Fund News)
