Introduction: 

On July 25, 2019, the sixth session of GLGA Lecture Hall was successfully held at the Innovation and Development Center, Green Legal Global Alliance. Today, we have our keynote speaker here, Mr. Guan Tao, doctoral supervisor of economics at Wuhan University, and Dong Furen Endowed Chair professor. He has long been engaged in research on currency convertibility, international balance of payment, exchange rate policy, and international capital flow, has written numerous work reports and academics, and participated in the design of a raft of major reform programs of foreign exchange management system from 1994 to 2014. In this lecture, Mr. Guan Tao will make an exclusive interpretation on trade friction, economic situation and RMB exchange rate. 

Understand exchange rate from two dimensions 

I am very glad to be here. Today, we'll focus on the trade friction, economic situation and RMB exchange rate. Before 2015, I gave lectures about foreign exchange administration generally combining the market with policy, which can help us better understand the exchange rate. On many occasions, most audiences only want the expert to directly tell them whether the RMB is appreciated or devalued, and their respective degree. 

However, it is hard to give an answer regardless of market or policy. From the perspective of the market, it is generally believed that the external market is an effective market, at which the random and non-linear price can reflect all the information. While with linearly extrapolated thinking, we'll think RMB will keep depreciating when it depreciates. The former chairman of the Federal Reserve Board (FRB) said that after half a century of exchange rate forecast, it was found that a humble attitude should be developed on the matter. From the perspective of the policy, there are three major policies on exchange rate, either management or free activities. In theory, both fixed and managed activities have advantages and disadvantages. There was no better system in the world. Theoretically, there is no exchange rate system suitable for all countries and all periods in a country in terms of international consensus on selection of exchange rate. 

We don't have any rigorous quantitative analysis in this respect. That's neither good nor bad for target priority (select or not) of the government. For the market, it is difficult to predict and explain the exchange rate. 

Today, I would like to share all of you from four aspects. Firstly, we should make a simple review on the trend of the RMB exchange rate since last year. In the event that the RMB exchange rate makes a difference in one-way appreciation. How is it affected by trade friction? It is the transmission mechanism of the impact of trade friction on the RMB exchange rate.  

Secondly, it comes to my views on Sino-US economic and trade frictions. The Chinese people have long regarded Sino-US economic and trade relations as the bedrock of Sino-US bilateral relations. In fact, Sino-US economic and trade frictions are an ongoing and complicated problem. It is not that easy as simple as we thought, and has nothing to do with concession and excellent performance. 

Thirdly, about the impact of trade disputes on the RMB trend, it is not simply asking whether the RMB is appreciated or devalued, instead, related logic, transmission mechanism, and future challenge should be clarified. 

Finally, it is some conclusion and suggestion. 

How does trade friction affect the RMB exchange rate? 

First, let's talk about the RMB trend since last year. At the beginning of last year, the US made Section 301 investigation against China, therefore, the negotiation failed. In June, the US imposed tariffs on China's first batch of goods. In a word, the RMB exchange rate experienced drastic fluctuation this year. So how does trade friction affect the RMB exchange rate? The logic is more important than the conclusion when we make analyses. 

In theory, the trade friction exerts an impact on three mechanisms of RMB, of which, the first affects market expectations, and safe and risk assets are used to characterize RMB asset attributes. Safe assets, just like USD and Japanese yen, can serve as safe-haven assets in a state of chaos. A subprime mortgage crisis incurred in the US triggered the global financial tsunami. When the crisis was at its worst, market hedging kept rising, however, the USD did not fall but rose, giving full play to the security attribute of USD assets. 

Is RMB a risk asset or safe-haven asset? China has started to advance cross-border RMB business since 2009, and it has gained a wider popularity all over the world, especially at the end of 2015, RMB was approved to be one of five major currencies. In recent years, RMB has been internationally well-known. According to the statistics of the People's Bank of China (PBC), more than 60 central banks hold the reserve assets of RMB. But in general, the RMB is a risk asset, not a safe-haven asset. 

For Russia, RMB is a safe-haven asset. As we know, the US has continually tightened sanctions on Russia due to hostile relations with western countries. Last year, Russia made a clearance reduction of US debts and sold them all. Afterwards, it bought gold, this is why there is an increasing number of gold in Russia over the years. It also bought RMB treasury bond. RMB can help Russia better mitigate sovereign risk due to worsening of diplomatic relations with the US. However, RMB still serves as a risk asset for other countries and regions. In theory, the risk assets mean that when risk aversion in the market prevails, there will be an increasing uncertainty, causing devaluation pressure on the currency. 

Sino-US trade friction, far above the market expectation, has increased the uncertainty of China's economic operation. Theoretically, uncertainty means risk, which is unfavorable for risk assets. 

Next, it is the trade channel. Due to mutual tax increase last year, it is believed that the Sino-US trade surplus will decrease. China's trade surplus is mainly from the US, indicating that the support of the RMB exchange rate market is weakened, which is not conducive to stabilizing RMB exchange rate. And the overall reduced trade surplus, including that with the US, has negative influences on RMB. 

Finally, it is the financial channel, the increase of Sino-US trade barriers may force foreign-invested enterprises to withdraw capital from China and make investments in other countries. This is one of the reasons of reduced investment in China. In addition, Chinese enterprises may increase their overseas investment. With increased foreign investment, and decreased external investment in China, our direct investment capital flow will decrease, which is not conducive to stabilizing RMB exchange rate. 

Theoretically, we should make conclusions based on the data, and overall judgments by means of the macro aggregate data. It is not that easy as simple as listening to stories, and the great possibility media will not make false reports on disinvestment of foreign merchants or well-known multinational companies by distorting objective facts. But even if it is real, it only accounts for a small number, with no comprehensive impact. Therefore, we still have to make judgments based on the aggregate data. 

In fact, according to statistics from both China and the US, we can see a trade imbalance between China and the US after two rounds of tariffs. However, the Sino-US trade is instead further expanded, a year-on-year increase of the trade surplus with the US of 17%. Although China's overall trade surplus is on a downward trend, the trade surplus with the US is increased. The trade surplus saw a reduction last year, which had nothing to do with trade friction since there is an increasing trade surplus with the US. 

According to US statistics, the US trade deficit with China has increased by nearly 12% last year. Based on the above data, the trade channel may have a negative impact on the RMB exchange rate in theory, but in fact, it doesn't, so we rule it out. 

What about the financial channel? There are two sets of data about financial channel in China, one is from State Administration of Foreign Exchange (SAFE). In 2018, direct investment in the international balance of payment decreased, net inflow of foreign direct investment increased by 21%, and net outflow of foreign direct investment fell by 6%. So we have increased external investment, and decreased foreign investment in China. From the perspective of total quantity, the capital inflow from decreased direct investment had a year-on-year growth of 62%. 

According to the statistics from the Ministry of Commerce of the People's Republic of China, including foreign investment, investment in China is a new capital inflow. Even if the investment decreases, there is bankruptcy liquidation or disinvestment, which is not calculated by the Ministry of Commerce. From the flow statistics of the Ministry of Commerce, it can be found that foreign investment reached USD135 billion in China last year, a year-on-year increase of 3%. It seems that it remains a slow growth, but the global foreign investment witnessed a year-on-year decrease of 19% last year. We still have positive growth, which is hard-won. We had maintained a positive growth momentum (increased by 3.5%) during the first half of the year. For that reason, the National Development and Reform Commission and the Ministry of Industry and Information Technology had held press conferences, highlighting that some foreign-invested enterprises have withdrawn, including Chinese enterprises increasing overseas investment. According to the statistics of the Ministry of Commerce, foreign direct investment had a year-on-year growth of 0.3% last year and 10% in the second half of this year. Therefore, it doesn't make any sense that China's overseas investment has significantly increased due to trade frictions. So for the second channel just mentioned, there is no decline in direct investment inflows of financial channels. 

Last year, the RMB exchange rate experienced drastic fluctuation. Before April 20, it appreciated by nearly 4%, and after that, it devalued since the USD rebounded (by around 5% from April 20 to June 15). During this process, we are on the basis of market supply and demand in line with the pricing formula of RMB exchange rate. Why? 

A basket of currencies and dollars is under the "Cogging Effect". After April 20, the RMB has depreciated against the USD due to USD rebound. Such as it is, it doesn't present great devaluation pressure like that in 2015 and 2016. So we had a low devaluation expectation. During this period, the closing price was generally appreciated by 6 cents. In mid-June, there was no devaluation in the market. On the evening of June 15, the US officially released a list of tariffs on Chinese imports. Later, Sino-US trade conflicts were incurred. On June 19, we had Dragon Boat Festival. The USD remained basically stable from the first trading day to August 3. However, RMB against USD fell to 6.8, why is this? The main reason was because Sino-US trade friction was far above the market expectation. As we just talked about, we have no expectations because the Chinese people have long regarded Sino-US economic and trade relations as the bedrock and stabilizer of Sino-US bilateral relations. 

Unexpectedly, the negotiation failed even though great efforts had been made. The US imposed tariffs on China's goods batch by batch, which had a great impact on the market. During this period, the closing price was devalued by 25 cents. It is not a currency manipulation, why? Because China introduced the pricing counter-cyclic factor in the beginning of last year without the intervention of the People's Bank of China, therefore, it is not a currency manipulation. In September last year, Prime Minister Li Keqiang made further clarification, stating that there was no government intervention. So there is not a currency manipulation without RMB appreciation and devaluation at the beginning of the year, which is determined by the market and caused by the Americans themselves. After August, the PBC worked out new measures to make adjustment on the trend of the RMB exchange rate. A new notice was issued on the evening of August 3, and the counter-cyclic factor was re-introduced at the end of August. From the beginning of August to the end of the year, the USD appreciated by 1.2%. During this period, the RMB only fell by 0.5%. Without regard to the USD appreciation and RMB depreciation, only taking account into the closing price, the RMB fell by 29 cents. In fact, the RMB exchange rate at the end of the year was 6.8632. This is what Prime Minister Li Keqiang said. We should make every effort to ensure the stability of the exchange rate. However, the government, independent of gold and silver and sales of foreign exchange reserves, stabilized the RMB exchange rate through counter-cyclic adjustment. 

In recent years, the Chinese currency has been over-issued, and the RMB has to fall against the USD, which may make sense, and be very reasonable. The central parity rate of the RMB calculated by the PBC via the quotation mechanism of RMB exchange rate plays a decisive role in RMB profits. The RMB doesn't rise above 7 (6.86), causing no losses. That was rare indeed in 2018. At the end of 2016, the RMB almost rose above 7 for the first time, with nearly RMB30,000 of foreign exchange reserves. At that time, many people expected the RMB could rise above 7, the same with HKD, and then targeted at 8. However, in fact, the RMB did not rise above 7 but 6 in 2017. Why is it? The RMB appreciation has nothing to do with supply and demand. In 2017, supply fell short of demand, but the RMB appreciated. Why did it happen? It was calculated by the pricing formula of RMB exchange rate, many enterprises are now distressed, why? At the beginning of 2017, everyone was very pessimistic since most of them failed to settle the foreign exchange. However, the RMB rose above 6 at the end of the year, and the Chinese enterprises made a profit by 3-4%. At the beginning of 2017, they failed to settle the foreign exchange. Therefore, they must leave out the interest margin between RMB and USD, as well as the entire export profit.