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Guan Tao: “Understanding the RMB” -- Basic Concepts of Exchange Rates (Chinese)
Summary of this issue
The evolution of the international monetary system and interpretation of its significance.
Why is the US dollar being called an arrogant hegemony by the international community?
The reasons for implementing the “floating exchange rate” system, and its practical flaws.
The basis for the current International Monetary Fund's monitoring of countries' exchange rate policies.
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Why is exchange rate policy now a major part of international economic policy coordination? The international monetary system has probably undergone such an evolution.
Before World War I, the gold standard system was implemented. Gold coins could be freely minted and freely exchanged, and gold could be freely transferred in and out across borders. Between the two world wars, the most common ones among countries were trade wars and currency wars (that is, competitive currency devaluation). Later, countries began to raise import tariffs, and finally, exchange controls and trade controls were generally carried out, and economic exchanges between countries were basically isolated. Under these circumstances, when the Second World War was coming to an end, the United States led the Bretton Woods Conference and established the basic framework for post-war global economic governance, which is the three important international economic organizations we know now: the first is the International Monetary Fund, which is responsible for managing exchange services around the world; the second is the World Bank, which is mainly responsible for providing development loans for post-war reconstruction; and the third is the multilateral trade agency, initially called the General Agreement on Tariffs and Trade, which was replaced by the World Trade Organization in 1995.
This is a global economic governance system established under the leadership of the United States, and it is also a public product provided by the United States to the international community by virtue of its absolute dominant position in the early post-war period. Therefore, everyone carried out trade, investment and financing transactions based on a single rule, avoiding vicious competition between countries such as competitive currency depreciation and imposing tariffs on each other.
The post-war international monetary system also underwent a series of changes. At first, other countries lacked foreign exchange, and the US ranked first in the world in terms of gold reserves and total economy. Under these circumstances, the US established the Bretton Woods system, which is a two-linked system — each country's currency is linked to the US dollar, and the US dollar is linked to gold. In other words, if you hold US dollars, you can offer the US to exchange the same amount of gold. At the beginning, all countries were in a state of shortage of dollars, also known as a dollar shortage. Gradually, America's trade surplus became a deficit, so the dollar crisis occurred in the 1960s. In order to stabilize the post-war Bretton Woods system, the international community adopted a series of relief measures, such as creating special drawing rights to save the US dollar and make up for the shortage of international foreign exchange reserves. In 2015, RMB was also approved to add special drawing rights, becoming the third-most important basket currency, and officially entered the basket on October 1, 2016. The international community has also used the gold pool to support the stability of the US dollar exchange rate, but in the end, the US dollar still cannot be maintained. In 1971, Nixon implemented a “new economic policy” and the dollar was decoupled from gold. In 1976, the Jamaica Conference announced the decoupling of national currencies and the US dollar, and the Bretton Woods system officially dissolved.
What does this process tell us? If a country's currency seriously deviates from its reasonable level, or equilibrium level, even if its total economy and total amount of gold rank first in the world, it is unsustainable. This is why countries are increasingly advocating greater exchange rate flexibility.
The current monetary system is called the post-Bretton Woods system, and the world has entered an era of no system. In the 1960s, the trade volume of the Federal Republic of Germany changed from a deficit to a surplus, bringing a large amount of foreign exchange earnings, causing pressure on the local currency to appreciate. However, under the Bretton Woods system, the currency could not appreciate at will, so it accumulated a large amount of US dollar reserves, causing domestic inflationary pressure. However, it is difficult to withstand the pressure of inflation, so the local currency appreciates irregularly. However, this practice violates the promise of a fixed exchange rate under the Bretton Woods system, so it has also been questioned and criticized by international organizations and the international community. Now, implementing a fixed exchange rate system will be criticized and questioned by the international community, and described as exchange rate manipulation; under the Bretton Woods system before the 1970s, fixed exchange rates were legal, and floating exchange rates were illegal.
The current international monetary system is still dollar-based. Two oil crises broke out in the early 1970s, and the importance of oil trading increased greatly. After the US dollar and gold were decoupled, the US government did a very important thing — mobilizing the OPEC organization to use dollar denomination to settle petroleum energy transactions, establishing a link between the US dollar and oil. In other words, as long as you need to trade energy and import and export oil, then the settlement currency is the US dollar, so regardless of whether you trade directly with the US or not, you have a demand for the US dollar. From this, we can see that currency internationalization should aim to become a denominated currency, not just a settlement currency. This is another very important reason why the US dollar can maintain its current position after the collapse of the Bretton Woods system. However, since the US does not assume the obligation to maintain a stable exchange rate and maintain the exchange of gold and US dollars under the Bretton Woods system, even though the US currently enjoys a hegemonic position based on the dollar, it does not assume any obligations. The international community calls it arrogant hegemony.
Before 2009, Central Bank Governor Zhou Xiaochuan wrote an article, “Thoughts on the Reform of the International Monetary System,” which proposed that the so-called Triffin problem of using sovereign currency as an international reserve currency still exists, so he advocates using supranational currencies to resolve some of the inherent vulnerabilities that sovereign currencies bring to the international monetary system.
Theoretically speaking, after the collapse of the Bretton Woods system in the 1970s, floating exchange rates were legal, so there should be no major problems with the floating exchange rate itself. However, in reality, one of the biggest flaws in floating exchange rates is that in the case of a floating exchange rate, the exchange rate is prone to excessive fluctuations; in theory, it is called an overregulation of the exchange rate. In the first half of the 1980s, a dollar bubble broke out in the US. At that time, the Federal Reserve held high the banner of anti-inflation and adopted a high interest rate policy, which caused high interest rates and high dollars, and created a dollar bubble, which led to a sharp expansion of the US trade deficit, putting some adjustment pressure on the US economy. Under these circumstances, the five Western countries jointly held the Plaza Conference in 1985, negotiated exchange rate arrangements between major currencies, and signed the “Plaza Agreement”. One important element in the “Plaza Agreement” is that the exchange rate of the yen and West German Mark against the US dollar greatly appreciated, so some people think that the “Plaza Agreement” is an important origin of Japan's current economic stagnation. Afterwards, since the US dollar fell too fast after the implementation of the “Plaza Accord”, everyone also believed that this move was bad for the US economy and brought great turmoil to the international market. Therefore, the Louvre conference was held in 1987. The members of the conference were expanded to seven Western countries, mainly to stop the dollar from depreciating too fast. As a result of the meeting, the “Louvre Agreement” was signed.
But in reality, now everyone only remembers the “Plaza Accord” and not the “Louvre Agreement”. Why? First, the impact of the “Plaza Agreement” is very far-reaching. Until now, everyone has closely linked Japan's economic stagnation to the “Plaza Agreement”. Including recent economic and trade frictions between China and the US, the “Plaza Accord” was proposed again as an important result of trade friction between Japan and the US. Second, the “Plaza Accord” worked. The US dollar did depreciate after the agreement was implemented, while the “Louvre Agreement” wanted to stop the depreciation of the US dollar, but it was not realized, and the US dollar continued to depreciate. why? I think the most fundamental reason is that the “Plaza Accord” is at the right time, just in time for the trend of depreciation of the US dollar. The conference confirmed market trends and accelerated market adjustments; however, when the “Louvre Agreement” was signed, market trends had not yet been formed, so government policy intervention alone could not change the exchange rate trend.
In recent years, the International Monetary Fund has also strengthened its supervision of countries' exchange rate policies. In 2007, a special revision passed the “Decision on Bilateral Supervision of Member States' Policies”, which included exchange rate issues in the important category of adjustments and introduced the concept of fundamental exchange rate imbalance. Fundamental exchange rate imbalance refers to relatively large deficits or surpluses generated by large-scale, long-term current accounts. In fact, one of the most important backgrounds is that at the time, everyone thought that the RMB exchange rate was undervalued. Because in 2007, China's current account surplus accounted for nearly 10% of GDP, and the international warning standard was ± 4%, so at the time, the international community generally believed that China had an undervaluation of the RMB exchange rate, which is what the US refers to as currency manipulation. This is also an important background for the “721 Foreign Exchange Reform” in 2005.
The above is the content of our section. I'm Guan Tao, thank you all.
Explanation of terms
The Bretton Woods system: A two-linked system — each country's currency is pegged to the US dollar, and the dollar is linked to gold.
Exchange rate overregulation: In the case of a floating exchange rate, the exchange rate is prone to excessive fluctuations. Theoretically, it is called an exchange rate overregulation.
Fundamental exchange rate imbalance: refers to a relatively large deficit or surplus generated by large-scale, long-term current accounts.
That is the content of this course, thank you all.
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