A Research For The Inside And Outside Value Bias Of RMB

In general, the value of currency has two different forms:one is the internal value, which we often call price; the other is the external value, which we often call exchange rate. According to internationally financial theory, the external and internal value of a currency should be the same. But since2002, RMB appears to have a bias with the characteristics that domestic depreciation and external appreciation and, under the context of world’s excessive liquidities and the devaluation of US dollar, the phenomenon has strengthened. It is the result of the unbalance in Chinese both inside and outside economy, which may impair the effectiveness of monetary policy and even get invaded by the international idle capital. So attention should be paid to this issue. This paper, thus, will aim to deeply analyze the various causes which give rise to the bias of domestic depreciation and external appreciation.This paper firstly reviews and summarizes related researches from domestic and foreign scholars. Standing on the shoulders of giants, this paper combs the classical theories of decision of the RMB exchange rate and the three international monetary system. The classical theories include Law of One Price, Purchasing Power Parity, Interest Parity, Balance of Payments Theory of Exchange Rate and Psychological Theory of Exchange. The three international monetary systems consist of Gold Standard System, Bretton Woods system and Jamaica system.Then, this paper focuses on causes of RMB’s external appreciation. It mainly derives from China’s rapid economic growth, the huge surplus of the current account, huge surplus of capital and financial account, rapidly increasing foreign exchange reserves, domestic and international interest rate spreads and psychological expectations of RMB appreciation.There are three manifestations of Inflation. They are:rising CPI, soaring investment in asset prices and negative real interest rates. Furthermore, this paper systematically explains several reasons why there is current inflation in China’s internal economy. First is monetary factor. Due to huge foreign exchange reserves, central bank is forced to put the excess money supply into internal economy. Second is economic factor. Demand exceed supply in the commodity market, the increasing cost of labor and raw materials, higher price of import goods, decreasing commodity supply due to natural disasters(such as earthquake) can easily lead to high inflation. Third is institutional factor:Some industries realize marketization too early. Such as agricultural market, for big foreign foods enterprises manipulate internal market prices. On the contrary, other industries which should be marketized do not trade goods by market disciplines. Thus, distorted relation between supply and demand inevitably brings about inflation.Besides, the bias of domestic depreciation and external appreciation is because of unbalance of internal and external economy context and is explicated by two new economic theories. They are Double effect—three-phase curve and Balassa—Samuelson effect. The former theory argues that external appreciation and inflation has two different relations:the substitution effect and the complementary effect. When internal and external economies become unbalanced, the complementary effect will exceed the substitution effect, the bias of domestic depreciation and external appreciation appears. The latter one holds that if a country’s economic growth is rapid, the tradable sector labor productivity will lead to a rise in the real exchange rate of the currency and believe the bias of domestic depreciation and external appreciation is a typical performance of increasing real exchange rate of RMB.In this paper, econometric analysis of the bias is also presented. Unit root test, Johansen co-integration test, Granger causality test, impulse response functions, variance decomposition, and the error correction model are used to measure statistical data from Jan.2002to Apr.2011. The result of Johansen co-integration test indicates that exchange rate, inflation rate and interest rate have a long-term stable relation. Likewise, error correction model result strengthens the proof that exchange rate and inflation are negatively related in the long term. Overall, empirical results show that RMB’s domestic depreciation and external appreciation indeed coexist.Finally, based on the failure example of Japan and the good one of Germany, taking the real home situation into account, suggestions are made, including: ①Appreciating of RMB moderately. According to Swan’s internal and external equilibrium model, to deal with domestic and international economic imbalances, China should match the expenditure switching policy with the expenditure changing policy effectively. Appreciating RMB’s exchange rate modestly is one of the most important measures to cope with the pressure from developed countries overseas.②Safeguarding the independence of monetary policy resolutely, and keeping implementing moderately tight monetary policy is another one suggested by Swan’s model. In addition, central bank be ought to improve the transparency of policy or take a variety of monetary sterilization measures to improve the effectiveness of monetary policy.③Accelerating the modification of the mode of economic growth. In the future, China need to continue promoting the optimization and upgrading of industrial structure, and further expand domestic demand.④Improving external economic policy. On one hand, our country has to convert the mandatory foreign exchange settlement system to a voluntary exchange settlement system in order to eliminate the vicious foreign trade surplus. On another hand, China needs having a perfect transition to the free flow of capital from capital controls to eliminate the severe asymmetry of the import and export of capital.⑤Fastening the development of internal financial market. Now, it is of importance to speed up the development RMB derivatives market. Based on RMB options and futures market, China should timely allow the RMB forwards and swaps, which will become the effective aversion tool of foreign exchange risk.⑥Quickening restructuring the exchange rate system and carrying RMB forward to the world. In the short term,"moderate appreciation-tax cuts" matching policy is needed to implement under the existing system, to release some pressure of appreciation and ease domestic inflation. Then, in the medium term, our country could shift the managed floating exchange rate system to a target zone system (such as the BBC system), to expand the target range of the RMB exchange rate fluctuations. In the long run, China should gradually lift foreign exchange controls in order to let RMB exchange rate float freely, and accelerate the process of RMB internationalization. At the beginning, China could learn from the experience of Germany, letting RMB circulate within the local surrounding and keeping the fact that RMB has become hard currency in the multilateral trade market. In this way, RMB appreciation pressure could be distributed to the currencies of neighboring countries, and then, domestic and external value bias of RMB might disappear gradually.