| The People's Bank of China announced on July 21, 2005 that the Renminbi(RMB) would adopt a managed floating exchange rate regime, based on market supply and demand with reference to a basket of currencies. To date, nearly four years have elapsed since the reform of exhange rate regime took place, heated debates have arisen in several fields concerning BMB currency basekt. Whether the RMB de jure refers to a basket of currencies while de facto pegs to the U.S. dollar(USD), which currencies are actually included in the RMB currency basket and their individual weights, as well as the determinants of an optimal RMB currency basket and its specific structure, are among the hot topics in academia. All these issues determines whether the RMB exchange rate are reasonable and scientific.The Frankel and Wei (1995)'s log-linear model has beome the dominant analytical tool in the existing empirical researches on the RMB currency basket and the Swiss franc(CHF) has been used as the denomiator currency in most studies. All scholars have reached the same conclusion that the USD exerts an overwhelming influence over the RMB exchange rate. On the matter of optimal currency basket for the RMB, however, huge differencs exist among present reserches. Researchers differ in both the methodologies adopted to decide the optimal currency structure and the specific currencies to be included in the currency basket. Most researchers conside bilateral trading relationship between China and its trading partners and trade flexibility to exchange rate in calculating optimal currency basket, while some take into account the capital flows between China and other countries. The USD, euro(EUR), Japanese yen(JPY), Korean won(KRW), Singapore dollar, Hong Kong dollar, New Taiwan dollar, Australian dollar(AUD), Canadian dollar(CAD), Malaysian ringgit, Great British pound sterling(GBP) and CHF have appeared in varied combinations as candidate currencies in the optimal currency basket.This paper follows the Frankel and Wei (1995) model to compare the realtionship between the RMB and 11 currencies announced by Zhou Xiaochuan, before and after 2005 exchange rate reform, taking into consideration of collinearity effect, using CHF and the Special Drawing Rights (SDR) as denominator currency respectively. The results show that after July 2005, the relationship between the RMB and a basket of currencies has changed dramatically. Before July 2005, the USD changes can account for almost 100% changes in the RMB exchange rate, with the adjusted square R of the regression close to unity; after July 2005 despite the dominant influence of the USD, other currencies began to affect the RMB with a significant coefficient and the adjusted square R of regression also decreased. The KRW has a secondary importance in the RMB currency basket, followed by JPY, EUR, GBP and AUD. Viewing the six currencies as componets of the optimal RMB currency basket, the thesis deducts several optimal weights using partial equilibrium analysis. Three perspectives are discussed: the share of bilateral trading relationship and their individual trade flexibility to exchange rate, the share of bilateral trading ralationship and their using of invoice currencies, as well as bilateral direct investments between China and the six currency areas. Ogawa and Shimizu (2003)'s three methods have been utilized to calculate the bilateral trading shares. For the purposes of stabilizing the RMB exchange rate to promote international trade, the criteria to select the best currency basket is to minimize fluctuations of currency basket value. The basket based on the bilateral trding relationship and invoice structure is found to exhibit only half fluctuations of the actual RMB exchange rate movements, while all the other currency baskets demonstrate greater fluctuations than the factual RMB exchange rate. |
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