Chinese Monetary Policy– exchange rate

Content

Important events in exchange rate management

The art of allocating wealth

Credit slaverize

Fact: rich becomes richer

two Key Milestones

1994 Jan. 1st integrate exchange rate market, consolidate and fix the exchange r

ate to 1: 8.7 USD

2005 July 21st Introduce “a basket of currencies” as for CNY exchange rate for ref

erences, appreciated 2% to 8.11 on that day.

1994 PolicyWhat the government did

price depending on “demand & supply” from government assigned bank, but actually it is a pegged system 1:8.7 US

D: CNY, with a floating allowance of 0.3% a day

USD is the only reference currency.

Consolidated the two market with a membership scheme,

All trade and settlement are done by inter-banking quote system.

Paying a premium on the supply of foreign currency in private sector.

A lot government intervention.

2005 policyWhat the government did

RMB appreciated 2% to 1: 8.11 USD on that very day

Added “a basket of currencies” as Reference currencies, they are: USD, HKD, JPY, EUR, GBP, MYR

Golden bull for Chinese stock market until 2007

Release the inflation pressure from huge international reserve

Chinese Exchange rate policy concerns

Americans insists that China is manipulating exchange rate to achieve price advantage to compete with American firms

in manufacturing industry

The Chinese policy makers view exchange rate policy as a means to achieve certain economical goalsTo avoid failure like Thailand in 1997,

To attract foreign investment fund

Monetary Policythe art of allocating wealth

分配財富的藝術

We all know about the three basic feature of money, medium of exchange, unit of account, and store of value. But in r

eal world, it is more than that.

There are several hidden identity of money

We all learned about the time value of money, there are two key elements: Time and Price, or interest rate.

Different price of money represented different future expectation of certain money

This indicates that the money today in different person’s possession does not necessarily worth the same to e

ach other.

We all learned about the time value of money, there are two key elements: Time and Price, or interest rate.

Different price of money represented different future expectation of certain money

This indicates that the money today in different person’s possession does not necessarily worth the same to e

ach other.

Monetary Policythe art of allocating wealth

分配財富的藝術

Government can make benchmark prices for money through monetary policy (by setting different interest rate, exchan

ge rate)

Government can control the future wealth of a society.

However, this is not the most powerful tool.

The most powerful tool is controlling the money supply. M1, M2, M2++ whatever

strategy:

Low inflation to encourage people to work hard

High inflation to lick up the wealth the people created.

Monetary Policythe art of allocating wealth

分配財富的藝術

Monetary Policytwo-person economy

But government can not just do that because there will be revolution fighting for this extreme unfairness.

So they change the name, by using credit.

Lets consider a two person economy

A plants for food to survive and provide all raw material, and B is in charge of building infrastructure and other producti

on for both of them.

Monetary Policytwo-person economy

Think about A getting a mortgage for a house in economically good time from B.

Pay only 20% of the total price, and borrow the rest under a “Monetary loose” phase. Borrowing to stimulate economy.

In economics terms, it is bringing the money from the future to the present. It is increasing Money Supply, but the reality is their wealth does not worth the same, or, their wealth is “l

everaged”

At the same time, people will pay for the price of borrowing, say 5% of principal a year.

Monetary Policytwo-person economy

Two years later, both A and B find that the price are inflated, as MS grows artificially by them. So B proposes to limit the credit to fight inflation, by doing so, interest rate has to go up, because supply of fund goes down, price of fund goes u

p.

But A borrowed money before, so his price of fund went up as well. There is no influence on B because he does not ne

ed to borrow.

Rich people are richer and richer.

Monetary PolicyCredit Slaverize:信貸奴化

Summary of two person model for credit slaverizing: three steps1. Grow the fleece:

Loosen credit limit during expansionary phase

Bring future money to present artificially increase money supply without creating anxiety

2. Hunting the sheep:

Tighten credit limit during contractionary phase

But it just stops bringing money from future to the present, it does not suck up the money brought before

3. Cutting the fleece:

Force the poor into bankrupt and take over valuable assets

increase debt burden of them by change the interest rate because they have to survive by relying on debt.

Benefit from lending money, as the first owner of the newly created money

Monetary Policythe rich gets richer

In China, the rich people are becoming richer and richer.

According to Huren.net, in 2009, there are 825,000 people who has more than ￥ 10,000,000 worth of asset in China including 51,000 people with assets more than ￥ 100,000,

000.

In 2010, there are respectively 875,000 and 55,000

Monetary Policy the rich gets richer

Combined wealth of top 10 richest year by year

Source hurun.net

Year Total Growth

2005 94.7B

2006 154.9B 63%

2007 543.0B 250%

2008 272.5B - 49%

2009 308.0B 13%

2010 405.0B 31%

Monetary Policy the rich gets richer

GDP per Capita in USD vs. Rich people wealth growth

Source: IMF. 2010 World Economic Outlook

Year Total Growth

2005 4102.495

2006 4748.661 15.75 %

2007 5553.39 16.95 %

2008 6187.707 11.42 %

2009 6778.091 9.54 %

2010 7517.717 10.91 %

Year Total Growth

2005 94.7B

2006 154.9B 63%

2007 543.0B 250%

2008 272.5B - 49%

2009 308.0B 13%

2010 405.0B 31%

Summary

There are two important Exchange rate policy adjustments 1994 and 2005

Mundel’s inconsistent trinity indicates that Chinese government is trying to allow free of capital flow in China

Monetary policy is a useful tool to allocate the wealth of a society by using money as the liability of the whole society.

Or credit slaverize

The rich gets richer and richer as a result.