A Research On Currency Composition Of China's Exchange Reserves In The Post-Financial Crisis Era

The foreign exchange reserve is an important indicator of external economic relations in an open economic environment. In accordance with it, a better understanding of a country's overall macro-economic operation would be obtained and the rational use of foreign exchange reserve which could benefit international equilibrium of balance of payments and external economic function fulfillment would be achieved. Previously, the study of the strategic adjustment of exchange reserves concentrated more on optimal quantity scale rather than currency structure. However, optimization currency structure has become priority of optimal reserves management. It can be explained from three aspects. Firstly, in a floating exchange rate system, a country's foreign reserves facing tremendous uncertainty of exchange rate changes. Secondly, there are numerous discrepancies between yields on monetary assets themselves due to the different development levels of each sovereign. Last but not least, the currency structure should satisfy the demand of trade and capital flows as much as possible, considering the function of foreign exchange reserves. Furthermore, the global financial crisis put the economics into a huge dilemma. Consequently, most of the individual sovereign currencies are struggling with the risk of devaluation. Specifically, our foreign reserves was dominated by dollars, thus how to use the structural adjustment of the currency to reduce the risk caused by dollar devaluation has already become the most urgent task of exchange reserves management.This essay focuses on two main issues, namely the choice of reserve currency and the weight of each reserve currency. According to previous researches carried out by eminent scholars at home and abroad, there are three main models (i.e. portfolio theory model, Heller-Knight model and Dooley model) and each has its own emphasis. In particular, portfolio theory model pays more attentions to the balance of benefits and risk. While the main emphasis of Heller-Knight model is the impact of foreign trade during the process of structure decision. In contrast, the effectiveness of foreign debt payments and exchange rate arrangements are the highlights of Dooley model. On the basis of these three models, this essay suggests that the currency structure of China's optimal foreign reserves should be the outcome of the combined effect of these three models. Therefore, on the basis of three models mentioned above, this study take various elements into account and then, to find the optimal currency weight.First and foremost, in the context of global financial crisis, this essay discusses the change of China's foreign reserves and inspiration we should gained. For instance, it is inevitable that a country would experience a huge loss if there are economic problems in their issuers of reserve currency. However, according to portfolio theory, whether a structure with a reasonable reserve currency portfolio could means totally different extent of risk. A case in point is China's overly dependent on dollars during the formation process, which now leads to irrational weight structure and a greater risk of loss when confronted with financial crisis.Additionally, based on comprehensive consideration of three research models and in accordance with the principles of related factors, this essay carried out a deeply analysis and what's more, the empirical estimates. In particular, the empirical researches'ideas built upon portfolio theory proceed, and then combined with the impact of other factors which would affect the currency structure of foreign exchange reserves. As a result, with the help of Heller-Knight model and Dooley model, obtained the reference for the optimal currency structure of foreign exchange reserves eventually.In a conclusion, built on the theoretical and empirical research, this essay firmly believes that a country's currency structure of foreign exchange reserves was determined by many factors (i.e. trade-off income risk, trade structure, the structure of external debt payment and exchange rate arrangements etc.). Only by taking all these elements into account, can we find the best currency structure. Additionally, being realized the fact of our non-optimal currency structure, we should be proactive in foreign exchange reserves management strategy, lower U.S. dollars and Yen which were in the situation of high risk devaluation, while add some weight to euro which considered as currency of stability, and get rid of dollar dominate eventually. Meanwhile, regarding the functional requirements of foreign exchange reserves, our goal of optimal currency structure can be achieved by changing trade structure, debt structure or any other such kind of structural adjustment. However, it should be point out that the ultimate resolution of China's foreign exchange reserves is the internationalization of RMB, that is convert RMB into freely exchange currency, it would be a long and complex process though.