Ladies and gentlemen,
Good afternoon! I am very glad to attend the Caixin Summit, and today I will focus on two issues.
The first is the RMB exchange rate. Some journalists said that I used the concept of Western medicine and Chinese traditional medicine to differentiate the approaches in the study of the RMB exchange rate when I attended the IMF/World Bank 2010 Annual Meeting in Washington not long ago, and they wanted to know whether they got me right. First of all, I indeed said that a drug from the Western medicine, which is based on theory and clinical trials, usually contains one ingredient and has a quick effect while a prescription of Chinese medicine include various ingredients that work together to treat a disease. There may be 10 ingredients in a Chinese drug and it usually takes a slightly longer time to cure a disease. People may infer from what I have said as to whether we want to do it quickly or follow a gradual approach. This understanding is direct as well as right. In fact, there are two meanings, and I would like to take this opportunity to give some explanations.
First, a prescription of Chinese medicine usually composes of various ingredients that have different functions and work together to treat a disease. In terms of alleviating the BOP imbalance, China need to shift its growth mode and restructure its economy, reduce reliance on exports, increase domestic consumption, and in particular, develop the services sector. All these measures are like the various components of a prescription of Chinese medicine, while the exchange rate is only one ingredient to play its role in treating the disease.
To expand the domestic demand is a very important ingredient of the medicine. As domestic demand expands, the balance of exports and domestic sales will witness a large change, imports will increase and the BOP surplus will shrink correspondingly. At the same time, wages will be adjusted upward, and the prices of energy and resources will further reflect market demand and supply and environmental costs.
In the past, the pricing of the environmental costs was relatively low. With the environmental costs priced to the actual level, some manufacturing sectors will feel the rising comprehensive social and economic costs. The price mechanism includes the management of tax rebates of exports. Overall, this package of policies is somewhat similar to a Chinese medicine prescription.
We hope this combined treatment is effective, and it also reflects our judgment that no single ingredient is particularly effective and can cure the disease on its own. This represents another approach to analyzing and solving problems.
Second, the Chinese medicine includes one method, i.e., dynamic adjustment or trial-and-error. The so-called dynamic adjustment means that a Chinese medical doctor will adjust the composition of the prescription according to the patient s condition, removing herbs, adding new ones and adjusting the dosage of some ingredients.
Overall, the adjustment is based on the feedback from the patient, and the feedback is also a process to observe the improvement of physical condition of the patient. As you can see, the dynamic adjustment is based on feedback of the patient. Chinese medicine, unlike Western medicine which has comprehensive and logical theories, relies on experiences in some respects.
Experiences are built on the basis of experiments and statistics, and may not be very accurate in some respects, while its logic can be adjusted. Useless medicines or medicines with strong side effects will be removed, or its dosage decreased, and this is the trial and error. I think this is a way of learning from experiences, which can be continuously adjusted in the process.
For example, we used to rely heavily on export tax rebate in adjusting the BOP accounts. Later on, however, we found that the adjustment of export tax rebate may have side effects, and it was inconsistent with the principle of equal competition. Thereafter, the strength and scope of this measure was adjusted on a dynamic basis, reflecting its continuous evolution and progress.
In short, the analogy of traditional Chinese medicine has three meanings: the first is a preference of a progressive approach to the radical approach of shock therapy; second, no single measure is expected to play a major role; third, dynamic adjustment is an ongoing process based on feedbacks and allowing for trials and errors.
The second is the QE2 of the U.S. Federal Reserve and its potential effects on China. Since this topic is being hotly debated, I would rather not say too much on it, and not comment on which is right or which is not. The Federal Reserve has contemplated on QE2 for some time, and the PBC and the Fed had communications on a number of occasions, including the regular bimonthly BIS meeting. In most cases, Chairman Ben Bernanke would attend the BIS meetings himself, while on other occasions other board members would attend. They have made a lot of explanations on the U.S. monetary policy. In the communication process, we felt that many of their comments were actually understandable. The U.S. Fed has the mandate to create jobs and maintain low inflation in the U.S. Given the fragile economic recovery, relatively high unemployment rate, low inflation rate and the U.S. federal funds rate close to zero, it is understandable that the Fed has adopted the quantitative easing monetary policy.
However, a key issue widely discussed is that the U.S. dollar is an international currency and a major international reserve currency. It not only serves as the main international reserve currency, and it is used in the pricing and trading of goods, especially commodities, and to a large extent, capital flows, foreign direct investments and financial market transactions are denominated in the U.
S. dollar. Therefore, the U.S. dollar has global impacts. If the QE2 is an optimal choice, or a second best choice for the U.S. itself, it may not necessarily be optimal for the world, and may have some side effects. This reflects the importance of the U.S. dollar as the major international reserve currency.
If we have any opinions, it may boil down to whether there are any problems in the current international monetary system, and whether it is necessary to resolve the issue from this perspective. As to international reserve currencies such as the U.S. dollar, if its international role conflicts with its domestic one, how should we explain and analyze such an issue?
As far as the QE2 s impact on China is concerned, the problem is: will there be a larger inflow of hot money? What measures should China take in response? As many people have offered their solutions, I just want to make two additional comments. First, China s current foreign exchange management still controls capital account.
Abnormal capital can choose to either stay away or take a detour. In the latter case, we can take regulatory measures to prevent hot money from coming. Second, I want to emphasize a significant measure, the sterilization operation at the aggregate level. When speculative capital comes in, we want to keep it in a pool rather than let it flood into China s real economy.
At the time when it retreats, we just let it flow out of the pool. We expect that this measure will largely neutralize the impact of abnormal capital flows on the China s macro-economy.
Indeed, another problem may arise: the capital inflows would make speculative profits from interest or exchange rate arbitrage. No one is happy about this except profiteers. On this I would like to say, on the one hand, we need to keep in mind the importance of sterilization; on the other hand, we should understand that, arbitrage always exists if there is such a chance and is almost unpreventable.
In late 1970s and early 1980s, when price difference across cities and across regions in China was so conspicuous that it gave birth to daoye , namely profiteers who made profits from trafficking and speculation. If chances exist in the goods market, it s almost impossible to stop arbitrage. As much as we do not like it, we still have to admit that it is an inevitable phenomenon of taking advantage of a money-making chance and is in accordance with the logic of market economy.
When trying to stop it, we have to first consider whether or not there are effective measures. It makes no sense to stop the rail road transportation in order to eliminate profiteering, because the benefit of the measure is dwarfed by the huge cost on the national economy. Therefore, the key lies in measuring the cost.
Similar problems also exist in the global financial market, such as the carry trade , which was a hot topic several years ago. At that time, Japanese yen were mostly used in arbitrage due to its low interest rate, and many arbitrages were yen/Australian dollar and yen/New Zealand dollar carry trade.
Then, who were doing the carry trade? If we could identify the major speculators or recognize the problems in the government s policies, we could find a solution. However, it is found that the speculations were mostly done by Japanese housewives, and it was difficult to prevent them from doing it. For China, therefore, it is most important to keep the macro-economy balanced, prevent risks, and conduct necessary sterilization operation.
Besides, we will try our best to prevent arbitrage and shut down those channels of arbitrage. However, it is impossible to root out all the chances for arbitrage.
To sum up, multiple angles are needed in the comprehensive analysis of the QE2 s global impacts. I have provided some of my perspectives and you are welcome to give your comments and critics. Going forward, more studies will be done on this topic.
Thank you!
