International Industrial Competition Perspective, A Country's Real Exchange Rate Formation Mechanism

Foreign exchange rate related topics have always been on hot debate in the field of international finance, for those puzzles have not been well explained and solved by existing theories of international economics. From the foreign classics, the existing theories can be classified roughly into to two schools-macro and micro-structure perspective. While the RMB has been going through reform since the year of 2005, domestic scholars have consumed a lot of time and efforts on the topic of RMB exchange rate. Therefore, thousands of different views have been published since then, and research papers'quality has been greatly improved.This essay seeks out to unveil the puzzles of foreign exchange pricing mechanism from the perspective of international industry specialization and global competition, and hence derives the general relationship between real effective exchange rate and the real economy. After theoretical analysis of one country's industry competiveness and many other important influencing factors of exchange rate, a mechanism called "Eight Logic Steps'is derived as a general way of analyzing the formation of real effective exchange rate. Afterwards, this essay analyzes the formation mechanism of RMB exchange rate, and concludes that the competitiveness of our mid and low-end manufacturing conclusively drives the appreciation of RMB real effective exchange rate. What's more, other factors such as monetary liquidity,nominal foreign exchange rate and roles of the government are also discussed in this paper.On the basis of theoretical analysis, Time Series analysis and Granger Causality Test are performed in the Chapter Four to test the reliability of the foregoing analysis. The competitiveness of Chinese low-end manufacturing and monetary liquidity M2/GDP are both found to be highly related to the RMB real effective foreign exchange. However, though Granger Causality Test, the rising competitiveness of Chinese low-end manufacturing is confirmed to be Granger cause of appreciation of RMB real effective foreign exchange, while M2/GDP is determined not to be. Therefore, empirical analysis corresponds with our theoretical logics.In the last part of this essay, policy proposals on industry upgrade and RMB reform are put forward. From the perspective of industry upgrade, government should choose the right industry to cultivate, while vigorously develops education and lows down the administrative barriers of industry investments. At the same time, we should notice that RMB reform still has a long road to go. Only when our industries are strong enough and our financial system is solid enough can we start the preparation for a floating currency.