Per reporter: Zhang Shoulin Per editor: Duan Lian
Recently, US President Biden signed the $1.9 trillion US economic rescue bill, and Biden has been committed to promoting a series of new policies after taking office. The bigger picture is that COVID-19 vaccination has spread across the globe. The global market is facing a new ecology, in this case, where will the US dollar and the renminbi go?
In this regard, the Daily Economic News reporter (hereinafter referred to as "NBD") recently interviewed Guan Tao, global chief economist of BOC Securities. He pointed out that the dislocation of the epidemic has led to the misalignment of the high point of economic growth between China and the United States, and the factors supporting the rapid appreciation of the RMB exchange rate last year have changed or are changing. A strong economy is a strong currency. Although the US dollar index has a clear impact on the RMB exchange rate, China's economic prospects are the most important factor affecting the RMB.
Image source: Courtesy of the interviewee
<h2>A strong economy is a strong currency</h2>
Guan Tao, Ph.D. in Economics, is the Global Chief Economist and Managing Director of BOCI Securities Co., Ltd., a doctoral supervisor of economics and a chair professor of Dong Fureng of Wuhan University, and a member of the First Steering Committee of China's Foreign Exchange Market. He has long been engaged in research on currency convertibility, balance of payments, exchange rate policy, international capital flows and other issues, written a large number of work reports and academic papers, participated in the design of a series of major foreign exchange management system reform programs between 1994 and 2014, and recently published the book "The Breakthrough of exchange rates".
NBD: Biden recently signed the $1.9 trillion U.S. Economic Bailout Act. How do you see the impact of the bill on the exchange rates of the US dollar and the renminbi?
Guan Tao: Biden's $1.9 trillion economic rescue bill has caused great controversy in the United States, and the main point of contention is in terms of scale. Former Treasury Secretary Somers has publicly declared that $1.9 trillion is overstimulating and "exacerbates" already high levels of government debt. Current Treasury Secretary Yellen defended Biden, saying the U.S. economic recovery has been uneven, with low-income earners, minorities and women hurting more in the crisis and requiring continued government support. Wall Street seems to lean more toward Summers' views. According to a Wall Street Journal economist survey, more than half of respondents believe the size should be less than $1 trillion. Wall Street has traditionally been more than happy to see flooding and sustained economic stimulus, but is also concerned that overstimulation will lead to "chicken feathers", that is, debt unsustainability and soaring inflation rates will lead to tightening policies. This, in turn, would amplify future economic uncertainty.
On the other hand, the main focus of $1.9 trillion is bailouts, including one-time checks, unemployment benefit increases and bailouts to local governments. One-off economic bailouts do not generate sustained revenues like investment spending, and in the long run will need to rely on other means to balance government deficits. Fed Chairman Jerome Powell also agreed at the FOMC press conference on Thursday that there is a need for fiscal policy that can alter potential output.
I mentioned several times in my annual strategy meeting in December and in my columns since then that seven major factors will affect the exchange rate of the renminbi this year, and that the factors that led to the rapid depreciation of the us dollar last year may reverse. The short-term stimulus of $1.9 trillion this time is relatively strong, and it is currently mainly responsible for the economic recovery and the Interest Rate Differential between China and the United States among the seven factors.
In terms of economic recovery, the ECONOMIC FORECAST FOR THE MARCH FOMC WAS SHARPLY RAISED TO 6.5% FROM DECEMBER, MEANING THAT THE FED EXPECTS ECONOMIC OUTPUT TO RETURN TO PRE-PANDEMIC LEVELS THIS YEAR. Even before the $1.9 trillion pass, the January IMF World Economic Outlook showed stronger U.S. economic growth expectations than Japan and Europe. This was true before the pandemic, and so has the economic trend since the pandemic. Interestingly, Powell was again asked by reporters on Thursday whether this fiscal and monetary policy could avoid the Japaneseization of the United States, that is, low inflation, low growth and high government debt.
In terms of the US-China spread, the market's expectations of the marginal convergence of the Fed's monetary easing have become more and more intense, and the US 10-year Treasury yield has soared from less than 1% at the beginning of the year to nearly 1.7%, causing the dollar index to stop falling and rebound to 92.
At present, the dislocation of the epidemic has led to the misalignment of the high points of economic growth between China and the United States, and the factors that supported the rapid appreciation of the RMB exchange rate last year have changed or are changing. Although the US dollar index has a clear impact on the RMB exchange rate, China's economic prospects are the most important factors affecting the RMB. If China's economy can get out of the downward channel of growth, the RMB exchange rate will still be optimistic about the market. The current situation is that the factors are one after the other, and the RMB exchange rate may not fluctuate in one direction as it has since June last year.
<h2>The renminbi may be the "new normal" of large opening and closing</h2>
NBD: Judging from the current comprehensive situation of various factors affecting the US dollar and the renminbi, how do you expect the rmb exchange rate to move in the coming year?
Guan Tao: In addition to the above-mentioned epidemic prevention and control, economic prospects, the US dollar index and the Sino-US interest rate differential, there are also export prospects, financial risks and major country relations.
When the outbreak first broke out last year, the market was very pessimistic about exports. But in the end, the global blockade, we took the lead in getting out of the epidemic lockdown, the export substitution effect pushed China's export share to a new high in recent years, and the domestic foreign exchange supply was oversupplied. So far this year, exports have once again exceeded expectations, and the transfer of orders triggered by the epidemic is still there. The market generally expects that before europe and the United States achieve herd immunity, China's exports are still supported, the window period is in the third quarter, and then China's export share may continue to decline to a level close to the pre-epidemic level. As for how much improvement can be achieved compared to before the epidemic, it will depend on how many orders are permanently transferred and how many orders are temporary. But the decline in export share should be more likely. In fact, after China's export market share hit a record high in the second quarter of last year, the third and fourth quarters have fallen quarter by quarter.
In terms of financial risks, there are some hidden dangers at home and abroad. The global central bank has released water, the stock market has hit a new high, and how much economic growth expectations have been overdrawn, which is worth paying attention to. Currently, the U.S. stock Schiller CAPE valuation level is in the second highest position in history, after the 2000 dot-com bubble. Non-financial corporate debt is high. Historically, every economic crisis has had a deleveraging process. However, this round of fiscal and monetary policy has achieved "no less than one", the reason is that "this crisis is not the fault of business operations, but the epidemic is caught off guard". But debt is debt, and this grey rhino will cause the market to be particularly sensitive to "deleveraging.". If financial risks break out, the safe-haven attributes of the US dollar will be highlighted, and whether the renminbi will be a safe-haven asset needs to be tested by the market.
Major-country relations are a long-term logic that affects the renminbi's exchange rate. The market also has a certain consensus on this, which may either develop in the direction of favoring the renminbi or bearish the renminbi.
Generally speaking, the period of continuous unilateral appreciation of the renminbi has passed, and the current equilibrium is near a reasonable level of equilibrium, and it is possible to enter the "new normal" of large opening and closing and two-way oscillation.
<h2>There is no currency that only goes up and doesn't fall</h2>
NBD: We are concerned that you published a book earlier this year, "The Breakout of the Exchange Rate", which mentioned that before 2014, the RMB exchange rate experienced unilateral appreciation for nearly 20 years. You also pointed out that the biggest drawback of floating exchange rates is that there are regular pro-cyclical exchange rate overshoots. Do you think there will be such a clear unilateral long-term trend in the future?
Guan Tao: Before 2014, the main reasons for the long-term unilateral appreciation of the RMB exchange rate were, first, China's foreign economic imbalance, the ratio of current account surplus to GDP was at the highest level of nearly 10%; second, China's economic growth rate was relatively fast, and the growth rate between China and the United States was larger; third, the RMB exchange rate was relatively rigid, delaying exchange rate adjustment, accumulating unilateral expectations, and stimulating risk-free arbitrage capital inflows.
At present, the first two factors have undergone great changes, the current account balance tends to be basically balanced, and the difference in economic growth between China and the United States tends to converge. Since 2016, the IMF has been assessing that the rmb exchange rate level is consistent with medium- and long-term economic fundamentals, and is neither overvalued nor undervalued. At the same time, in recent years, the market-oriented reform of the RMB exchange rate has made substantial progress, and some commentators have said that it has entered the era of "quasi-free floating", which is conducive to the timely release of depreciation pressure and avoid the accumulation of unilateral expectations. Therefore, last year, we witnessed the trend of the RMB exchange rate first suppressing and then rising, opening up and closing widely. In the case that the exchange rate is determined by the market, the factors affecting the rise and depreciation of the exchange rate exist at the same time and the other is long, there is no currency that only rises and does not fall or only falls and does not rise, but it must be that it will rise if it falls more, and it will fall when it rises.
However, any exchange rate option has pros and cons. The implementation of a flexible exchange rate mechanism has the advantage of helping to curb risk-free arbitrage capital flows by increasing exchange rate flexibility, but it is sometimes easy to excessive appreciation or depreciation of exchange rates driven by pro-cyclical capital flows. In particular, if market participants are not mature enough, lack risk neutral awareness, and chase up and kill in the foreign exchange market, it is more likely to have a herd effect, resulting in an overshoot of the exchange rate. It is precisely for this reason that the marketization of the exchange rate should be promoted simultaneously with market education.
In addition, after the outbreak of the financial crisis in 2008, in the face of the huge impact of capital flows, the academic community has further reflected deeply and put forward the so-called "binary paradox", that is, in the case of free flow of capital, whether the exchange rate is fixed or floating, it is impossible for countries to obtain full monetary policy independence. Thus, in the wake of the crisis, the IMF has increased its tolerance for capital flow management, recommending that member countries introduce a macroprudential management framework to iron out pro-cyclical cross-border capital flow shocks as exchange rate flexibility increases. In recent years, China has also made some useful attempts and explorations in this regard and has accumulated certain experience.
<h2>The outlook for the renminbi is positive</h2>
NBD: Do you think that with the rise of national strength, can the RMB exchange rate one day break through 6, or even reach below 5?
Guan Tao: The precondition for this question is the rise in national strength. The bilateral exchange rate is the comparative relationship between the two countries. If national strength refers only to GDP growth and economic aggregates, China's economic aggregates will be getting closer and closer to the United States, but in the past few years, our economic growth rate has been faster than that of the United States, and the RMB exchange rate may not have been appreciating. Therefore, a single national strength to predict that the renminbi will one day rise above 6 is too one-sided. If the national strength you are referring to is a comprehensive factor, such as the economic and financial system, industrial structure, scientific and technological development, global influence, labor productivity and potential economic growth rate, etc., now, the Chinese government pays more attention to economic quality. According to the logic of a strong economy and a strong currency, if China achieves scientific and technological breakthroughs, optimizes the demographic structure, and thus walks out of the channel of inertial decline in economic growth, coupled with a more perfect exchange rate system, the prospects of the renminbi are still optimistic. It also means that we may be close to the date when the renminbi rises above 6. After the war, both the German mark and the Japanese yen experienced this leap in foreign currencies.
As for whether the RMB exchange rate will further rise below 5 to 1, I may be more cautiously optimistic about this. Because even from the perspective of the exchange rate determination theory of purchasing power parity, rising above 5 is more challenging. According to data from the International Monetary Fund's latest World Economic Outlook database, the purchasing power parity of the renminbi in 2020 was 4.24 to 1, down 11% from the level in 2014 when China's economy reached the top of the world in terms of purchasing power parity. Not to mention that in 1980, in the early days of reform and opening up, the purchasing power parity of the renminbi was only 1.50. By the middle of this century Chinese while the average income of the middle of the century reaches the level of a moderately developed country, we still have a lot of more arduous work to do to effectively maintain the existing real purchasing power of the renminbi.
<h2>Monetary policy does not focus on single asset prices</h2>
NBD: You mention in your new book that central banks should not get too close to the stock market. But foreign central banks such as the Federal Reserve seem to have had many bailouts. So, how do you understand this view?
Guan Tao: Why the Fed shot and what impact the Fed had on the stock market after the move, these are two different questions.
Before the 2008 financial crisis, most central banks did not advocate intervening in capital markets, pursuing the so-called "Jackson Hole Consensus" of "good faith neglect" of asset price fluctuations. After the crisis, the central bank realized that maintaining price stability was not enough to achieve financial stability, so it included financial stability in the central bank's goal, but formed two major propositions for asset price fluctuations: after-the-fact clean-up and headwind intervention. The Fed remains committed to its pre-crisis views, with its current chairman, Jerome Powell, in November 2018 at the Economic Club in New York city, introducing the Fed's basic framework for monitoring financial stability, stating that there can be no macroeconomic stability without financial stability, and that systemic risks tend to sprout in boom times. Thus, in the aftermath of a crisis, policymakers no longer rely on immediate policy responses, but instead constantly monitor vulnerabilities within a framework that proposes solutions in advance during boom times, and requires firms to plan ahead for financial pressures. It can be seen that the Fed has incorporated financial stability into its policy objectives, but in practice, its responsibility for financial stability is still mainly monitoring. For asset price fluctuations, the Fed has followed the previous practice of using monetary policy tools to intervene against headwinds in advance, but to clean up the damage caused by financial turmoil after the fact through the central bank's "lender of last resort" role.
Historically, the Fed's "lender of last resort" role has typically worked in two situations: when asset prices fluctuate sharply, causing market liquidity to tighten suddenly, the central bank provides liquidity to the market and maintains the normal operation of the market; the other is when asset prices soar or plummet, affecting inflation, growth, and employment, and the central bank responds through monetary policy operations. The most typical is that the Fed opened up liquidity support and successfully resolved the stock market crash on Black Monday on October 19, 1987, which made Greenspan famous and left behind the legacy of "Greenspan buy options".
Last year, the Fed sacrificed the "zero interest rate + unlimited width" of the king of the explosion, in just one year to expand the balance sheet of nearly 3 trillion US dollars, 10-year US Treasury yield as low as 0.6%, the last three rounds of quantitative easing for more than six years a total of 2.3 trillion yuan, the US Treasury yield as low as 1.4%. This led to a V-shaped rally in U.S. stocks last year, which soared by more than 40 percentage points as a percentage point of U.S. stock value to GDP throughout the year, compared with more than 70 percentage points in the six years from 2009 to 2014 during the last crisis. Obviously, this wave of US stock markets is a "buffalo" market driven by the flood of liquidity.
However, the Fed's unprecedented release of water did not stem from the "seven consecutive falls" of US stocks at the end of February last year, but because after entering March, the new crown pneumonia epidemic evolved into a pandemic, which caused a huge impact on financial markets and the real economy. The Fed's larger-than-expected flooding is to block the spiral of liquidity crisis caused by financial market panic. But in the short term, these measures have not prevented the US stock market from fusing four times in ten days. At that time, the biggest uncertainty in the stock market was epidemic prevention and control and fiscal policy. The Fed is also well aware that monetary policy can only provide liquidity, not solve the problem of survival. However, fed rate cuts spur demand release and inflation upwards, as well as encourage risky behavior (the meaning of savings declines), and stocks tend to respond more quickly. With the gradual implementation of epidemic prevention and control and fiscal stimulus policies, excess liquidity will be reflected in the stock market first.
As for the connection between the stock market and monetary policy, the fed's key officials have explained many times that monetary policy does not pay attention to a single asset price, the real economy is the most important, and changes in asset prices will trigger financial conditions and finally affect the real economy. It is now proposed to include asset prices in inflation targeting. In fact, the current practice of central banks in some developed countries is to use the consumer price index to measure inflation, while constructing a monetary and financial condition index, including a wide range of financial indicators such as interest rates, exchange rates, stock prices, housing prices, broad credit, and M2 to measure market liquidity. The central bank then implements monetary policy accordingly in advance, or evaluates the effect of monetary policy accordingly afterwards. Moreover, the central bank's influence on the financial system is too large, once the central bank's intentions are misread, a little carelessness will be interpreted as "the central bank sees the risk we do not see", coupled with the concept of "do not confront the central bank", the stock market may be directly overshoot. Direct financing in the United States accounts for a larger proportion, and the stable operation of the stock market and bond market is of great significance to the Fed, so there is Fed put option protection.
<h2>The Asian financial crisis has caused many reflections</h2>
NBD: You repeatedly mentioned the 1997 Asian financial crisis in your book The Breakout of the Exchange Rate. At that time, the loss of the Thai baht triggered the Southeast Asian currency crisis, which in turn evolved into the Asian financial crisis. You had been working for the State Administration of Foreign Exchange for many years and witnessed the crisis. Can you describe what happened at that time and how the loss of foreign exchange affected Southeast Asian countries such as Thailand?
Guan Tao: On July 2, 1997, Thailand lost its baht and the Southeast Asian currency crisis officially broke out. After that, it gradually evolved into the Asian financial crisis that swept through the world's emerging markets. Thailand, South Korea, the Philippines, and Indonesia have complained to the International Monetary Fund, Malaysia has introduced fixed exchange rates and restarted capital controls, the yen, Singapore dollar and New Taiwan dollar have depreciated sharply, and the Hong Kong joint exchange system (also known as the currency board system) has been repeatedly attacked. Its effects continued until the end of 2001 and the beginning of 2002, when Argentina implemented a ten-year system of convergence. In the meantime, it also triggered the Russian financial crisis in 1998, which led to the collapse of the Long-Term Capital Management Company in the United States.
The Asian financial crisis reversed the trend of the rmb exchange rate rising steadily since the 1994 exchange rate was merged. At that time, the Chinese government promised not to depreciate the renminbi, while at the same time implementing an active monetary policy to ensure growth. According to the "ternary paradox" that monetary policy independence, exchange rate stability and free capital flow cannot be combined, it is reasonable to strengthen capital control. According to the new "impossible triangle" theoretical framework proposed by me, in the face of the imbalance between supply and demand of foreign exchange, either the price is cleared by exchange rate fluctuations, or the quantity is cleared by foreign exchange intervention or capital control. The Chinese government clearly does not want the RMB exchange rate to depreciate, nor does it want to consume foreign exchange reserves to stabilize the exchange rate (and even continues to demand more reserves, which is not out of consideration for the independence of monetary policy), and strengthening and improving foreign exchange management has become an inevitable choice. Therefore, since 1998, the relevant departments have adopted measures such as launching a networked verification system for import and export customs declarations, strengthening the verification of the authenticity of foreign payments for current accounts, restricting foreign exchange purchases and foreign investment in capital projects or repaying debts in advance, and intensifying law enforcement efforts to crack down on evasion of foreign exchange.
The Asian financial crisis has caused much reflection. For example, rethink the pros and cons of capital flow liberalization. At the Hong Kong Autumn Conference in July 1997, the IMF considered amending its statutes to extend the jurisdiction of currency convertibility from the current account to the capital account. However, due to the crisis, the motion was shelved indefinitely, and the international community returned to caution about the opening of the capital account. At the same time, everyone has also begun to realize that financial opening up and trade opening cannot be simply compared: the Asian region has created an Asian economic miracle by engaging in export-oriented and trade opening-up, but engaging in financial centers and financial opening has led to the Asian financial crisis. Immature financial openness often ends in crises, and lessons learned in emerging markets are common.
Another example is the renewed widespread concern about exchange rate options, including exchange rate regimes and exchange rate policies. The Asian financial crisis has shown once again that rigid exchange rate arrangements and capital-account liberalization are dangerous policy combinations. At the beginning of the crisis, the theoretical community once believed that the exchange rate could only survive if it was completely fixed or floating, and that the intermediate choice of managed floating was unsustainable, which was the so-called "hollow theory" of optimal exchange rate selection. However, because fixed, floating and managed floating exist objectively in reality, the theoretical circles in the later period have a new understanding of this, and gradually reach an international consensus that there is no single exchange rate choice suitable for all countries and all periods of a country. Behind this is the pros and cons of each exchange rate option. For example, there is an "intermediate solution" that manages floating because of the lack of transparency and credibility, in the case of speculative attacks, the multiple equilibrium of the foreign exchange market is prone to bad results, and can not effectively prevent currency crises. This is very helpful for us to understand the policy logic of the "8.11" exchange rate reform.
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![Guan Tao, global chief economist of BOC Securities: At present, there will be neither policy decline nor policy increase[fig]](data:image/gif;base64,R0lGODlhAQABAIAAAP///wAAACwAAAAAAQABAAACAkQBADs=)