Unilateral Appreciation Expectation Is The Important Background Of "7.21" Reform.

Since the "7.21" exchange rate reform in 2005, China has been promoting the marketization reform of RMB exchange rate for ten years. However, it is rather coincidental that the current exchange rate reform (the "8.11 reformed") environment is similar to that of other times, facing the unilateral expectation of exchange rate, but the appreciation of the renminbi at that time, and this time is the depreciation, and the related effects and problems caused by it are more complicated.

The author believes that although the economic background of these two reforms is not completely comparable, however, in some technical details, the practice and experience of "7.21" reform is still worth learning, including the high pparency of the new exchange rate formation mechanism, the "change mechanism" far beyond the "level adjustment", and the weakening of the topic of RMB appreciation on the expected guidance.

With the outbreak of the "9.11" terrorist attacks and the collapse of the US high-tech bubble, the Fed sharply reduced interest rates and the dollar weakened from strength to strength.

By the end of June 2005, the US dollar index had fallen by 23.7% compared with the end of 2001.

In the second half of 2001, China had brewed the Asian financial crisis at a time when the RMB exchange rate returned to a managed float.

However, because of the international financial turmoil and the reversal of the US dollar trend, the reform plan to improve the RMB exchange rate formation mechanism has been shelved.

During the period, the RMB exchange rate continued to remain stable against the US dollar. Even from October 2004, the central parity rate was set at 8.2765 per day, resulting in the depreciation of the RMB against the US dollar against other major trading partners.

In the same period, nominal and actual Renminbi

They depreciated by 13.5% and 15.1% respectively.

The passive depreciation of the RMB exchange rate during this period is considered to underestimate the RMB exchange rate.

At the end of 2002, Kuroda Higashihiko, deputy director in charge of international affairs in Japan's Tibet Province, published an article in the financial times, pointing to China's export of deflation to the world through currency manipulation, and opened the prelude to international revaluation of the RMB exchange rate.

Since then, US lawmakers have clamored to include China in the currency manipulation list and pressure the RMB exchange rate to be revalued or threaten to impose trade sanctions against China.

Since the second half of 2001, China has recovered a large amount of capital and its foreign exchange reserves have increased significantly.

From the three quarter of 2001 to the two quarter of 2005, China's quarterly average capital account surplus was 20 billion 200 million US dollars, which was 13.2 times higher than that of the first quarter of 1998 to the two quarter of 2001. After excluding the valuation effect, the average foreign exchange reserve assets (the same quarter) increased by 33 billion 600 million US dollars, an increase of 10.5 times (see Figure 2).

It can be seen that before the reform in July 21, 2005, the RMB exchange rate has accumulated a long period of unilateral appreciation expectations.

To cope with this pressure, since 2002, China has gradually introduced measures such as relaxing the restrictions on purchasing foreign exchange and holding foreign exchange, raising the standard of personal remittance, implementing capital account payment and settlement management, and so on.

At the same time, the authorities restarted issuing central bank bills and raising the required reserve requirement ratio, which hedged the impact of imported liquidity surplus.

During this period, the authorities also seized the favorable opportunity for the rapid growth of foreign exchange reserves, creatively used foreign exchange reserves to inject capital, and supported wholly state-owned banks to replenish capital and share reform to go public.

The "7.21" exchange rate reform is carried out under the pressure of unilateral appreciation, while the "8.11" exchange rate reform is in a unilateral depreciation environment.

Of course, the economic background of these two reforms is not completely comparable.

Because theoretically, the supply of local currency can be unlimited. If we do not care about the pressure of domestic inflation and asset bubbles, the central bank's ability to cope with capital inflow and currency appreciation will be much stronger than when the situation reverses.

However, in some technical details, the practice of "7.21" reform is still worth learning.

First, we should pay attention to the initiative of public opinion.

As mentioned before, the "7.21" environment of exchange reform is that the international community is putting pressure on the RMB exchange rate to be revalued.

Therefore, the exchange rate reform has only a one-time appreciation, but the focus of the publicity work is on "changing the mechanism" rather than "adjusting the level".

For the reasons for the one-time appreciation adjustment, there are only one or two sentences to explain.

In order to prevent the market impression that China was forced to carry out foreign exchange reform under external pressure, the central office and the State Affairs Office issued a special document to deploy the whole society, including the military system, to publicize the initiative, gradual and controllable "three characteristics" principle of RMB exchange rate reform. This shows that the government always adheres to an independent and highly responsible attitude on the issue of RMB exchange rate, and persists in choosing the exchange rate system and exchange rate policy suitable for China's national conditions starting from the fundamental interests of China and the reality of economic and social development.

Second, we should pay attention to the smooth pition of the old and new systems.

From the old system to a new system, the key is to establish the credibility of the new system quickly, and the pparency of the new system is crucial.

"7.21" reform, although the official declared that the renminbi is no longer a single peg to the dollar, but refers to the basket currency to adjust the RMB exchange rate trend, but in the specific operation, through the arrangement of the intermediate price pricing mechanism (that is, referring to the closing price of the previous day), it ensured the credibility of the new system, reduced the unnecessary speculation of the market, and restrained the excessive expansion of the unilateral exchange rate.

It was not until early 2006 when the market maker system was introduced into the interbank market that the intermediate price was changed to market by market maker before opening.

Trading Center quotation, remove the highest price, the lowest price after the weighted average formation.

Compared with the previous pricing methods, the latter is less pparent and becomes the "black box" formed by the middle price.

Third, abandon the illusion of one-time adjustment to achieve exchange rate equilibrium.

The "7.21" exchange rate reform will increase the RMB exchange rate by 2.1% at a time.

The interpretation of the PBC is that, according to the calculation of the reasonable and balanced exchange rate, this adjustment is mainly determined by the degree of China's trade surplus and the need for structural adjustment, and the adaptability of domestic enterprises to structural adjustment is also considered.

Admittedly, the one-off appreciation has released the pressure of RMB appreciation to a certain extent, and restrained the space of "hot money" inflow arbitrage.

However, the equilibrium exchange rate can not be quantified in advance, based on the bilateral exchange rate.

The exchange rate adjustment is obviously not enough to correct the imbalance of the RMB exchange rate.

After the exchange reform in 2005, the RMB exchange rate rose to 33.0%% against the US dollar before the beginning of 2014, and the nominal and real effective exchange rates of the yuan appreciated by 32.4% and 41.6% respectively (see Figure 3 and figure 1).

Moreover, the success of "surprise" can not be duplicated.

When the market adapts and expects the RMB to appreciate unilaterally, arbitrage funds will continue to flow into the market.

From 2006 to 2008, the RMB appreciated 18.1% against the US dollar and the foreign exchange reserve assets increased by an average of US $408 billion 200 million per year, representing an increase of 1.6 times compared with the average annual increase from 2002 to 2005 (see chart 2).

Since the outbreak of the international financial crisis in 2008, the renminbi has become the most attractive spread trading currency in the world. A large number of "hot money" inflows to acquire foreign exchange spreads and spreads, let alone holding other higher yielding renminbi assets.