On The Mobilization Of China's Foreign Exchange Reserves Under Local War

After the Cold War, local wars such as the Bosnian War, the Gulf War, the Kosovo War, the Afghanistan War, the Iraq War, broke out one after the other and the world has not changed its situation that local wars happened frequently before 1991. The probability that China will involve in the local war in the foreseeable future should not be underestimated because of its great reunification undertaking unfinished and the anfractuosity of its political and military circumstance. Financial mobilization is needed to win a war for abundant social resources depleted in local war. Since the 1990s, "double surplus" has become a normal pattern of China's balance of payments, leading to China's foreign exchange reserves ranks first in the world in absolute terms, the foreign exchange reserves accounted for more than 40 percent its GDP. As a result, China's foreign exchange reserves can be mobilized under local war. However, the practical experience of foreign exchange reserves mobilization is scarce because China's foreign exchange reserves has been less than 1 billion US dollars from 1949 to 1979, and China's armed forces depended mainly on financial support and social donations in the local war that happened in the past. In the academic community, many literatures studying in peacetime related issues of foreign exchange reserves is very systematic and in-depth, the research of industrial mobilization, agriculture mobilization, transport mobilization, telecommunications mobilization, public debt mobilization of, revenue mobilization, etc. are also quite bon, but mobilization of foreign exchange reserves under local war is not. Therefore, studying on the mobilization of China's foreign exchange reserves under local war is particularly urgent.In this paper, literature reviewing is done at first; Secondly, the feasibility of China's foreign exchange reserves is studied from the perspective of local war; Thirdly, the scale of China's foreign exchange reserves which can be mobilized under local war is calculated, and the analysis on foreign exchange reserves mobilization impact is done; Finally, the main conclusions are educed. The paper has six chapters aggregately.In Chapter 1 which titled "Introduction", the research tasked on the mobilization of China's foreign exchange reserves under local war is put forward at first, and then key concepts such as foreign exchange reserves in this paper are defined, finally the difficulties, innovation and limitation of research are described.In Chapter 2 which titled "Literature Review", relevant literatures about mobilization of China's foreign exchange reserves under local war are reviewed according to three core issues as following: (1) the ways and safe effectiveness of foreign exchange reserve mobilization under local war; (2) calculation on the China's foreign exchange reserves scale which could be mobilized under local war; (3) economic effects analysis on China's foreign exchange reserves mobilization under local war. The results showed that the local war variable do not been taken into account in the financial field and foreign exchange reserves mobilization is often been overlooked in the field of economic mobilization.In Chapter 3 the in-depth analysis on endogenetic and ectogenic causations for the nonequilibrium growth of China's foreign exchange reserves is done. In order to mobilize its foreign exchange reserves successfully under local war which maybe break out in the future, China should prepare for the mobilization, that is, a part of foreign exchange reserves ought to be transferred into gold reserves and the currency restructuring of China's foreign exchange reserves ought to be done to increase Euro assets according to military security. Chapter 4 answers the question of how much foreign exchange reserves could be mobilized under local war. Under the guidance of the relevant theoretical modeling, in whith the variables are selected according to China's actual situation, the Chapter ultimately gets the dynamic scale of foreign exchange reserves that can be mobilized by using the ARIMA model and the double-exponential smoothing method to predict. The Chapter also points out that there will be significant changes in foreign reserves which must be taken into account when the mobilization is implemented after the outbreak of local war.There are three key issues of foreign exchange reserves that must be settled, the first one is the feasibility of foreign exchange reserves mobilization, second is calculation of the scale of mobilization, and the last one is the analysis of mobilization impact. The last issue is solved by analyzing in Chapter 5. Apart from the obvious military effectiveness, that is, the mobilization related to the outcome of local war, the most significant impact of foreign exchange reserves mobilization is on monetary base and then inflation. The impact of the mobilization under local war is surveyed through co-integration test, vector error correction model, impulse response function and variance decomposition based on vector autoregression.Chapter 6 comes logically to the following four main conclusions: (1) increasing the amount of gold reserves and the Euro assets will augment the probability to mobilize China's foreign exchange reserves successfully; (2) the dynamic process showing the scale of China's foreign exchange reserves can be mobilized under local war can be divided into three stages; (3) the degree of sensitivity of monetary base to China's foreign exchange reserves mobilization is significantly stronger than the other variables; (4) the mobilization impact has its characters of delay, persistency and stability.The econometric empirical analysis methods are widely used in this paper. The Cencus X12 seasonal adjustment method is applied to modulate related data which influenced by the seasonal factor in this paper. China's foreign exchange reserves in the end of 2007 and 2008 are forecasted by applying the annual data from 1978 to 2006 and using the autoregressive integrated moving average model, which is advocated in Chapter 4 to be employed in predicting China's foreign exchange reserves in or after the end of 2009. The trend item of the optimal foreign exchange reserves in the future is predicted by using the Holt-Winters no seasonal model. The Hodrick-Prescott filtering method is adopted obtain the trend item of economic time series. The Co-integration theory brought forward by Engle and Granger and the vector error correction model are adopted for modeling unstable time series in empirical analysis. The multivariate co-integration test procedure advanced in Johansen (1988) is applied because the multivariable testing is involved in this paper.The response function method is used to measure the trajectory of the current and future variable value impacted by a standard deviation coming from innovation. The variance decomposition method is applied to evaluate the contribution of various structures impulsion on monetary base. Before using IRF and variance decomposition methods to analyze foreign exchange reserves mobilization impact on monetary base, the stability test of the vector autoregression model established has been done by adopting the method which initiated by Lutkpohl (1991).The empirical analysis is difficult to overcome its own weakness despite it is indispensable for studying on the mobilization of China's foreign exchange reserves under local war. Scholars including Hayek, who is a liberal economist, have given a stern warning on the shortcomings of empirical research. It needs not only empirical analysis which has judge characteristics but also normative analysis judging the value to study on the mobilization of China's foreign exchange reserves under local war.The study on the mobilization of foreign exchange reserves involves many macroeconomic issues and the military, political, diplomatic and other non-economic issues, and these need value judge. The problems such as China's military security situation, the probability of local war outbreak, the war outbreak of the time and place, the odds of freezing parts of China's international reserves by hostile nations, etc. can not be basically solved through empirical analysis. It needs scientific normative analysis and sometimes needs a certain assumption on these issues. In accordance with the historical facts, the status quo of China's reunification unfinished, the normative analysis is adopted in studying the related issues of foreign exchange reserves mobilization. This paper studies on how many China's foreign exchange reserves can be mobilized, what kind of impact the mobilization will bring to monetary base, etc. supposing that the probability of the"war in the Taiwan Strait"outbreaks is large. Moreover, once the "war in the Taiwan Strait" outbreaks, the paper makes greater probability assumption that the United States and Japan will intervene in the local war. Therefore, the paper makes normative analysis on the preparative of foreign exchange reserves mobilization.Calculating the scale of China's foreign exchange reserves could be mobilized under local war is one of the major innovations in the paper. The theoretical basis for decisions of foreign exchange reserves has been established by Kenen & Yudin (1965), Heller (1966), Miller & Orr (1966), Frenkel (1974), Iyoha (1976), Hamada & Ueda (1977), Frenkel & Jovanovic (1981), Edwards (1983), etc., which have done a lot of research on the optimal size of foreign exchange reserves. Lane & Burke (2001), Aizenman & Marion (2003), Narayan & Smyth (2006) generally focus on the impact factors or optimal size of foreign exchange reserves, not the scale of foreign exchange reserves could be mobilized under local war. The literatures such as Liu Zhengxin and Sun Zhaobin (2006), etc. are quite imperfect although they study on the scale of wartime mobilization. This paper measures systematically on the scale of China's foreign exchange reserves which could be mobilized under local war. China's foreign exchange reserves and its scale which can be mobilized in the future must be estimated because possible outbreak of a local war happens in the future. The ARIMA (1, 1, 1) model is established to forecast China's foreign exchange reserves. According to the theory of the ARIMA model or the experience of the actual forecast results obtained by Chi Qishui (2007), the forecast error of foreign exchange reserves is relatively small. In order to obtain the equilibrium scales of foreign exchange reserves in each year, the paper selects GDP, the opening degree of current account, the opening degree of capital account, the average import tendency as independent variables, and foreign exchange reserves as dependent variable to make out regression analysis. The scale of China's foreign exchange reserves can be mobilized from 1979 to 2006 is estimated in the paper, at the time, the scale can be mobilized at the end of 2007 and 2008 is inferred based on the ARIMA (1, 1, 1) and Holt-Winters models, and the idea of the scale estimation in 2009 and after that is also presented. The calculation results show that China's foreign exchange reserves can be mobilized scale is a dynamic process, which can be roughly divided into three stages as follows: from 1979 to 1993, basically can not be mobilized stage; from 1994 to 2002, can be sustained medium-scale mobilized stage; from 2003 on, can be sustained largely mobilized stage.The impact analysis of China's foreign exchange reserves mobilization on the monetary base is another major innovation in the paper. Numbers of literature such as Heller (1976), Khan (1979), Mohsen & Janardhanan (1997), Lane & Burke (2001), Aizenman & Marion (2003), Narayan & Smyth (2006), Zhou Hao, Zhu Qigui (2006), Fang Xianming, Peiping, Zhang Yihao (2006), basically do not have the variable of local war considered. There is standpoint in the vast majority literature which did not take local war into account deeming China's current foreign exchange reserve scale is too large. Wang Zhen (2005), Yue Yiding, Zhang Xuan (2007) educe that China's foreign exchange reserves growth caused the monetary base expansion, thereby resulting in inflationary. The issue that the increasing of foreign exchange reserves put pressure on monetary base should be re-examined because changes in external economic conditions under local war will generally reduce a country's foreign exchange reserves, which will further reduced by its mobilization. This paper does demonstration analysis on the impact of foreign exchange reserves mobilization on monetary base. It shows that China's foreign exchange reserves mobilization under local war can reduce the increasing press of monetary base. There is a long-term equilibrium relationship existing among the variables because the co-integration equation has good statistical properties and all the independent variables are statistically marked. The coefficients of the variables and their statistical markedness show that the impact of foreign exchange reserves on monetary base is greatest. In case of other conditions unchanged, the change rate of the monetary base will reduce by about 40 per cent if the change rate of foreign exchange reserves mobilization increase one per cent. The error correction mechanism is for negative feedback process and is statistically significant. Monetary base is affected by foreign exchange mobilization and other variables. The long-term equilibrium among the variables selected in Chapter 5 will be realized after the short-term error correction, the rate of which is 27 per cent. The short-term impact of the mobilization of foreign exchange reserves on monetary base is significantly stronger than the other variables'effect under local war. The trajectory of the impulse response indicates that the monetary base is impacted by foreign exchange reserves. The response curve apparently shows that the reaction mechanism with the influencing characteristic of lasting and stability. The results of variance decomposition shows that in the first period of time the proportion of the monetary base contribution is 100% because of all the changes in the monetary base are coming from their own standard error, and then its contribution is gradually declining. There is a certain lag exist because the impact of foreign exchange reserves mobilization to monetary base does not exist in the first period of time. The contribution of foreign exchange reserves mobilization under local war to the prediction error of monetary base is gradually increased from 0% to around 36%.