Research On Currency Substitution And Policy Options Of Anti-currency Substitution

Currency, as a universal equivalent, plays the role of transactions media, value storage, pricing unit and means of payment in modern economy. Since the 1970s, because of control deregulation and financial liberalization, even in a country's economic system there will be various freely convertible currencies or certain degree of currency convertibility. So the appropriate role local currency plays lies in the people's confidence in the local currency. It can be imagined that if in the national economy, serious inflation or currency devaluation expectation or other political, economic changes occur, there will be weakened public confidence in the stability of the local currency. To lower costs, improve relative returns, avoid exchange rate risks or facilitate transactions, rational economic will use foreign currencies to replace local currency in economic activities, thereby creating the currency substitution issue. Objectively speaking, under the conditions of an open economy the currency substitution is an inevitable product of free capital flows. Certain degree of currency substitution may also have a useful role in the economic operation. However, we must note that with the deepening of currency substitution, this monetary disturbance is likely to have a far-reaching impact on the stability of the domestic financial and capital markets and the macroeconomic operation. Operation of the economy in some countries also illustrates this point. With China's accession to the WTO, China is gradually opening its capital market. So we need to carefully study the causes of currency substitution, factors influencing currency substitution degree and currency substitution's possible negative impact on the domestic economy. We also need to prevent the deepening of currency substitution degree from having a negative impact on China's good economic performance to ensure that problems are solved before they actually cause trouble.Based on the existing research home and abroad, this paper makes detailed discussion on the origin of the currency substitution issue, the reasons for the occurrence of modern currency substitution issue, and makes theoretical analysis and empirical testing about the factors affecting China's currency substitution degree in the current stage. For the measurement methods, first use the ADF test to show the first-order difference stationarity of variable sequence, then use Granger causality test to show that the scale factor, the difference in domestic and foreign interest rates and the exchange rate are the effective independent variables influencing currency substitution degree, finally, use data from the first quarter, 1998 to the fourth quarter, 2006 to estimate the equation. Empirical test results are satisfactory and correspond the theoretical analysis, disturbance series without serial correlation. Specifically, a significant positive correlation exists between exchange rate and difference in interest rates between domestic and foreign currency and currency substitution, that is, the higher the exchange rate between dollar and RMB, the deeper the degree of currency substitution. The higher the dollar deposit rate, the lower the RMB deposit interest rate. People will tend to use dollars to replace RMB to keep currency value, thus the degree of currency substitution enhanced. Otherwise the result is opposite. For example, since 2006 the continual increase of RMB value and the banks'increasing deposit rate will to some extent decrease the degree of currency substitution . Weak negative correlation exists between GDP and currency substitution because of the rapid growth of China's GDP, continual economic growth, increasing RMB value and the public's increased confidence in RMB. Inflation factors failed to pass the Granger causality test, that is, the current data do not support that the rate of inflation at this stage is the reason of currency substitution, which is contrary to the theoretical analysis. A study of the reasons, perhaps because there exists irrationality in the compilation of the consumer price index (CPI),which did not fully reflect changes in the prices of daily necessities, could not reflect the true extent of inflation, and thereby affected the creation of an empirical model of currency substitution.In the above analysis, This paper also focuses on the influence of the currency substitution upon monetary policy, fiscal policy, exchange rate, inflation tax and international payments, etc. in the process of capital opening up .Currency substitution is a monetary disturbance under the condition of free flow of capital and is likely to have a far-reaching impact on the stability of a country's financial and capital market and macroeconomic operation. Therefore, we must strictly watch the currency substitution degree to avoid the possible negative impact. Finally, based on Guidoui's anti-currency substitution theory--- "inaction band" theory, this paper makes relevant policy recommendations on how to control currency substitution degree in the process of capital opening up, Including controlling the inflation rate, carring out flexible exchange rate system, setting up RMB long-term foreign exchange market and enhancing the effective supervision of capital flows, choosing the path of gradual opening up to control the pace of the reduction in currency substitution costs, and preventing emergence of the phenomenon of mass currency substitution.The main achievements lie in the following aspects :according to the practice of free flow of capital under open-economic conditions, this paper makes detailed analysis of possible causes of currency substitution issue and the content of modern currency substitution; put forward the currency demand function suitable in China, and establish a theoretical model of currency substitution; using the latest data, this paper makes an empirical analysis on the factors influencing China's currency substitution degree, further confirms that the difference in domestic and foreign interest rates and the exchange rate are the major factors influencing China's currency substitution degree in the process of capital opening up; according to the reality of China's ongoing capital opening up, this paper discusses the possible economic impact of currency substitution and offers the corresponding preventive measures.