Devaluation Of Foreign Exchange Reserves Will Lead To Financial Risks.

Just as interest rate is the price of capital, exchange rate reflects the supply-demand relationship between the two currencies.

For example, Japan's M2 at the end of 2006 was 714 trillion yen, but now it has only increased to 940 trillion yen, and the M2 in ten years has increased by only 32%.

Why is Japan's currency growth so slow? The reason is that the balance of loans in Japan has been declining over the past ten years, although the overall GDP is still rising.

However, China's M2 has increased by 345% over the past ten years.

Whether they are Japan or the United States, their central banks are crazy about money supply, but commercial banks are very temperate, which is the fundamental reason for the stable value of money in developed countries.

In this sense, the strength of money has nothing to do with the strength of the economy, but it has something to do with the supply of money.

More precisely, it is related to the growth rate of money relative to economic volume.

If the money supply increases synchronously with GDP, it shows that the money supply has not increased significantly.

China's M2/GDP ratio continues to expand, indicating that China's currency expansion is too fast, despite the central bank's foundation.

Not much, two years or even reduced, but the scale of credit creation of commercial banks is very large.

If in 2006 as the base period (RMB entered the appreciation stage), when the exchange rate of RMB against the US dollar was 1:8.08, the 1 yuan M2 corresponding to the 2006 variable price would correspond to 0.63 yuan GDP, which is now 0.32 yuan GDP. Meanwhile, according to the 2006 variable price, the corresponding GDP of 1 US dollars is 1.97 US dollars, now it is 1.19 US dollars.

This shows that the efficiency of China's monetary expansion is decreasing.

Although this comparison is not entirely reasonable, it can generally indicate that the supply of RMB to the US dollar is obviously too large.

In addition, we can also confirm the overestimation of the RMB exchange rate from China's inflation level relative to the United States. For example, in 2003 -2015, China's cumulative inflation relative to the United States was 30%, that is, China's price increase was 30% higher than that of the United States, but in 2003, the exchange rate of RMB against the US dollar was 8.28:1 and 2015 was 6.23:1, which means that the RMB appreciated 25% against the US dollar in the past 12 years, but inflation increased by 30% over that of the United States.

If there are logical flaws in judging the overvaluation of RMB exchange rate from two angles of excess or relative inflation, the most intuitive way is to observe the willingness of Chinese residents to exchange foreign exchange.

China Construction Bank data show that in 2014, foreign assets accounted for only 1.6% of the total assets of domestic residents, but the proportion of overseas assets in the developed countries accounted for more than 15% of the residents' asset allocation, and many developed small countries were even around 30%.

With the emergence of asset bubbles and asset shortage in China, residents continue to increase the allocation of overseas assets, so the demand for foreign exchange will be large, leading to weaker currency exchange rate.

From the perspective of foreign exchange supply, although China's FDI growth and export surplus continue to increase, foreign exchange reserves have decreased by US $about 870000000000 since June 2014.

Moreover, in the first three quarters of 2016, the balance of payments by banks on behalf of clients was more than 1 trillion and 600 billion yuan, compared with 400 billion in the same period in 2015.

In addition, despite the decline in foreign exchange reserves this year, compared with the same period last year, in the first three quarters, China's non reserve financial account reached a record high of about 200000000000 US dollars.

The above data show that China's demand for foreign currency assets as a global currency superpower is very large, and the room for improvement is also very impressive. At the same time, the current rate of foreign exchange loss is fast and the supply is tight.

No matter whether it controls foreign exchange or exchange rate control, it is difficult to change the expectation of depreciation unless it adopts a one-off and large depreciation method similar to that implemented in 1994.

Why

Generally speaking, the currency will be oversimplified. The logic is very simple, because compared with the international currencies of the developed economies, their liquidity and convertibility are poor, and their sovereign credit ratings are also poor. This is like a stock of the main board, and the third is a new three board stock. The former has good liquidity and high financial pparency, and the valuation level can certainly be higher than the latter.

Theoretically speaking, the risk premium is usually equal to the liquidity premium plus the credit premium, and the risk premium rate of emerging economies is higher, so the phenomenon of super depreciation has become the norm.

The nominal depreciation rate of many emerging economies is mainly due to the fact that most of them rely on currency expansion to cope with economic difficulties. So are the BRICs of China, Brazil, South Africa, India and Russia.

As at the end of 1976, the US dollar was 8.97 against the India rupee, and now it has risen to 66.7. In the past 40 years, the depreciation rate of the rupee against the US dollar has reached 644%, and the Russian rouble has been devalued more than hundreds of times. In the past 40 years, the value of the rouble has fallen to 644%.

Wang Xiaodong studied the trend of the US dollar index (Major), which is the 7 major international currencies to the euro, yen and sterling in early 1973, and found that the US dollar index has only depreciated about 15% so far. However, the US dollar index (OITP) of some 20 countries such as China, Russia, India, Brazil, South Africa and Mexico has appreciated more than 70 times in the same period.

Although the economy of the OITP countries is flourishing relative to the major countries, the exchange rate has exceptionally depreciated.

Some people believe that China will not tolerate the continued depreciation of the renminbi, because a significant depreciation will affect China's goal of entering the high-income countries in 2020. At the same time, the United States will not tolerate a significant depreciation of the renminbi, which will lead to an expansion of the trade deficit between the United States and China.

I think there is some truth in this formulation, but the key is to change the expectation of devaluation, because excessive money will always find ways to vent, or inflation or asset bubbles.

If we can reduce the supply of RMB or expand the supply of US dollars, the relationship between supply and demand will be reversed, or excessive depreciation can be avoided.

Since the beginning of this year, with the downward trend of interest rates, the overall financial risk has actually declined, because the cost of high leverage has dropped.

Despite the boom in real estate and the increase in leverage in residential housing, asset bubbles have also intensified. With the introduction of property market control policies such as restriction, the real estate fever has cooled, and the level of leverage of residents has basically stabilized.

But no matter how to regulate and control, hot money always moves from one market to another, such as the stock market fever in the first half of last year, the hot property market this year, and now the hot market of foreign exchange.

The relationship between exchange rate and interest rate seems to be negatively correlated, that is, the monetary authorities usually raise interest rates in order to prevent excessive exchange rate depreciation.

This year, the central bank's M2 growth target is set at 13%, but it is estimated that it can not be achieved because the foreign exchange occupation as the main source of the central bank's basic currency will decline for 12 consecutive months as the depreciation expectation increases, and it will make a negative contribution to the total amount of M2. At the same time, after the real estate has cooled down, its ability to create credit will also weaken, and the leverage level of real estate enterprises and buyers will stabilize, which will slow down the growth of M2.

In addition, with the increase in the rate of interest raising in the United States, the dollar held by various countries flows to the United States.

Over the past ten years, the interest rate of the US Treasury bonds has risen sharply. The average interest rate rise in the US, Japan, Europe and China has averaged 30-50bp in recent years, equivalent to one or two increases in interest rates.

In addition, the US dollar index has reached a record high, triggering a massive return of capital to the US, leading to a significant depreciation of the emerging market exchange rate.

Therefore, we can simply deduce: devaluation leads to a decrease in foreign exchange holdings, leading to tighter liquidity and higher interest rates, and rising interest rates will lead to falling asset prices.

In addition, depreciation will lead to an increase in the import price of commodities. In order to deal with the depreciation, the relatively undervalued physical assets such as precious metals and commodities are regarded as hedging or speculative varieties, inducing the rise of commodity prices, making hot money flow from the capital market to the commodity market, thus raising the level of inflation.

Inflation expectations are rising at the beginning of this year, which will also push interest rates upward and then pierce them.

Bubbles.

Once the asset bubble is punctured, the probability of a financial crisis will increase.

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In order to avoid sustained devaluation and change the expectations of domestic residents for the devaluation, it is better to tighten the money instead of passively to tighten the money. Tightening the currency is actually changing the supply and demand relationship of the local currency to foreign currencies, because inflation, devaluation or asset bubbles are all the result of excessive currency. One of the ways to deal with it is to tighten the currency.

As mentioned before, the level of exchange rate depends on the supply and demand relationship between the two currencies. If the growth rate of RMB supply decreases, the downward pressure on the RMB exchange rate will also decrease.

Of course, the reduction in the growth of money supply is bound to further reduce the economy and lead to higher interest rates, but this is the inevitable price.

Two of the coping strategies should be increased. Foreign exchange control should continue to be strengthened. Foreign exchange control should be carried out under both trade and capital terms, because foreign trade can also become a means of evading foreign exchange.

Despite the increased control, it is difficult to change the expectation of depreciation, but we can achieve the goal of changing space with time.

For example, the US dollar index is stronger now, but I believe this round of the US economy is also weak recovery. If the US dollar index weakens in a year or two, the expectation for the continued depreciation of our currency will naturally weaken.

Three of the solutions should be made to reduce the decline in foreign exchange reserves, because from the past data, the change of foreign exchange reserves is basically the same as the exchange rate changes. If foreign exchange reserves are no longer reduced, the exchange rate can basically be stabilized.

On the one hand, the stability of foreign exchange reserves can be achieved by strengthening regulation. On the other hand, we should not sell US dollars for the sake of currency stability and thus consume foreign exchange reserves. We should adopt the strategy of "win without war".

Only when foreign exchange reserves are no longer falling, the demand for domestic residents to exchange foreign exchange will drop sharply.

After all, China is still the largest country in the foreign trade surplus so far, which has a stronger foreign exchange advantage than other emerging economies.

In response to the problem, four, the intensity of deleveraging needs to be increased, because excessive leverage is the inducement of the outbreak of the crisis.

When domestic leverage decreases, the impact of devaluation on domestic economy and finance will naturally drop.

Judging from the changes in China's foreign exchange reserves, China's foreign exchange reserves peaked in June 2014, lagging behind the top of the appreciation of the exchange rate (6.04) for 5 months, and began to decline gradually after reaching 3 trillion and 990 billion dollars.

In October 2016, the scale of China's foreign exchange reserves was 3 trillion and 120 billion, the highest point decreased by US $876 billion 800 million. Therefore, it can be generally considered that the RMB has entered the cycle of depreciation.

In short, when the currency is over or the asset bubble is already a fait accompli, if we can not directly reduce the leverage or go to the bubble, we will try to mitigate the risk through the way of lowering interest rates. This is essentially a stalling tactic, and the problem always exists, only to expose it in different ways under different conditions.

In general, depreciation is more harmful than profit. Devaluation is the result of economic weakness. Therefore, it can not be the cause of economic strength at the same time.

Just as foreign exchange reserves are rising as a result of the continued inflow of foreign exchange, we can not believe that the current global reserve is the reason why domestic currencies will not depreciate significantly. The trend of foreign exchange reserve determines the direction of exchange rate upward or downward.