Thoughts after the sharp drop in the RMB exchange rate - using Bitcoin to store foreign exchange among the people

Chapter 0 Introduction

This week, the RMB exchange rate against the US dollar plummeted, sparking a hot topic on Weibo. While this topic is hot, I would like to express the view of "lifting foreign exchange circulation controls and allowing exchange rates to float freely" through this article. And in the case of Bitcoin becoming a convenient cross-border currency, analyze the bottom-up approach to lifting foreign exchange controls.

Chapter 1 International Trade and Foreign Exchange

What is foreign exchange? The following definition is extracted from the "Foreign Exchange Administration Regulations of the People's Republic of China" issued by the State Council.

Article 3 Foreign exchange as mentioned in these Regulations refers to the following means of payment and assets denominated in foreign currencies that can be used for international settlement:

(1) foreign currency notes, including paper money and coins;

(2) foreign currency payment vouchers or payment instruments, including bills, bank deposit vouchers, bank cards, etc.;

(3) Foreign currency-denominated securities, including bonds, stocks, etc.;

(iv) Special Drawing Rights;

(V) Other foreign exchange assets

To put it simply, foreign exchange is the currency issued by countries other than one's own country.

Because each country regards issuing its own currency as a symbol of sovereignty, and does not allow foreign currencies to circulate in its own country (there are exceptions). Therefore, trade between countries will be troublesome. For example, when people from China and the United States do business, Americans buy Chinese clothes. Americans must first buy RMB in the foreign exchange market and then pay the Chinese merchants. The foreign exchange market is everywhere, and of course the most important one is the central bank of each country.

So how are exchange rates between currencies formed?

Chapter 2 How Exchange Rates Are Formed

Everyone is so concerned about the exchange rate of the RMB, so the question is, what exactly is the exchange rate?

Regarding the mechanism of foreign exchange formation, the definition in textbooks is really difficult to understand. Here is a simpler and more accurate explanation of the exchange rate formation mechanism.

The exchange rate between the currencies of country A and country B is determined by the demand of the people of country A and country B for the goods of the other country, as well as the supply of goods available for trade between country A and country B. For example, the exchange rate between the RMB and the US dollar between China and the United States. If China has no demand for American goods, that is, the Chinese do not need to buy anything from the United States, then there is no exchange rate between the RMB and the US dollar. If the demand for American goods by the Chinese increases, the RMB will depreciate relative to the US dollar, assuming other conditions remain unchanged.

In fact, the reason is very simple. If Chinese people want to buy American goods, they must first exchange RMB for US dollars. The more goods they buy, the more US dollars they need to exchange. It is equivalent to using RMB to buy US dollars. If the supply of US dollars does not change (that is, the Federal Reserve will not print US dollars for free, and of course it cannot print US dollars randomly), the US dollar will appreciate. In the past, 6.2 RMB was exchanged for one US dollar. The US dollar guy saw that you wanted too many US dollars, and the US dollar is going to increase in price now, so you can exchange it for 6.5 RMB. In this way, the RMB depreciated against the US dollar.

Chapter 3 Main Causes of Exchange Rate Fluctuations

There are a lot of difficult to understand reasons in textbooks, and it is generally said that the following four factors affect exchange rate fluctuations.

Foreign exchange is determined by four factors: purchasing power parity; inflation in various countries; international trade balance; and financial speculation.

I think scholars may do this for academic requirements, or for greater accuracy, or for royalties, or for the mathematization of calculations, but anyway, those things are too difficult to understand.

As far as I understand, there are two factors that affect exchange rate fluctuations:

1. The changes in the demand for each other's goods and the supply of their respective tradable goods.

2. The change in the money supply used by countries AB for trade.

This definition can be qualitative but not quantitative, but it is accurate. For economic analysis, the market is too complex for mortals to analyze quantitatively. Those experts who claim to be able to predict economic trends are generally liars.

If country A's demand for country B's goods increases, with other conditions remaining unchanged, country A's currency will depreciate relative to country B's currency, that is, country A will have to use more currency to buy country B's goods.

However, if the money supply of country A used for trade increases, other conditions remaining unchanged, the currency of country A will depreciate relative to the currency of country B, that is, A will need more currency to buy the same amount of goods from country B.

A typical example of the latter is that when the United States was implementing QE, the U.S. dollar generally depreciated against other currencies in the world, but now that the U.S. dollar is withdrawing from QE, the exchange rate is appreciating.

Chapter 4: Reasons for the sharp drop in the RMB exchange rate against the US dollar this week

There are various opinions in the market about the reasons for the sharp drop in the RMB, and I will just add some more confusion.

1. The Chinese central bank has printed too much money, and the Chinese who have received the money have increased their overseas asset allocation. That is, the RMB is still a high-quality currency, and China is exporting inflation.

2. The cost price of raw materials imported by China's manufacturing industry, such as oil, iron ore and other commodities, has fallen, so they can be sold at a lower price. The central bank has reduced the price and increased exports by devaluing the RMB. For example, before, 100 US dollars could only be exchanged for 620 RMB, which could only buy 10 pieces of Chinese-made clothes. Now if you use 100 US dollars, my central bank will exchange more for you, giving you 650 US dollars, so you can buy more clothes, 10.5 pieces. It would be fine to sell it at a lower price, but they have to manipulate foreign exchange.

3. As the U.S. dollar withdraws from QE, the amount of U.S. dollars used in trade with the Chinese will decrease.

Chapter 5 Strategies for Disposing of Foreign Exchange

There are generally three types of foreign exchange strategies for a country.

1. Linked exchange rate

That is, the domestic currency is exchanged with a certain foreign currency at a fixed exchange rate. The currency issuing authority will exchange the two currencies at the specified exchange rate regardless of how the market exchange rate fluctuates. This will inevitably lead to a black market exchange rate.

2. Autonomous exchange rate

That is, the currency issuing authority decides the amount of currency to be issued at its discretion. For example, it creates a basket of commodities, stabilizes prices, and keeps a close eye on CPI. This is actually the currency issuance policy.

3. Exchange rate control

That is, the government imposes restrictions on foreign exchange in order to balance international payments and maintain the exchange rate of its own currency (relative to a certain foreign currency, or a basket of foreign currencies). For example, the central bank limits the amount of foreign exchange that people can exchange, or the central bank adjusts the exchange rate through foreign exchange reserves and foreign exchange sales.

Article 27 of the "Regulations of the People's Republic of China on Foreign Exchange Administration" promulgated by the State Council stipulates that the RMB exchange rate shall be subject to a managed floating exchange rate system based on market supply and demand. Article 32 stipulates that the State Council's foreign exchange administration department may adjust the foreign exchange market in accordance with the law based on changes in the foreign exchange market and the requirements of monetary policy . These two articles clearly indicate that our government will intervene in the foreign exchange market, and the exchange rate is not only determined by market supply and demand. In essence, China implements a controlled exchange rate.

Chapter 6 How the Foreign Exchange Market Works

A country's foreign exchange is mainly obtained through exports and labor services, which is called foreign exchange earnings. For example, Chinese people sell clothes to Americans, and Americans give us dollars. Another example is that Chinese people go to the United States to wash dishes, and Americans pay Chinese people dollars as wages.

When a country buys foreign goods or services, it needs to spend the foreign exchange it has earned.

If there is no government involvement, the free trade of goods and services between the two countries' citizens, exporting enterprises or selling services is production behavior, and using foreign exchange to purchase foreign goods and services is consumption behavior.

In a free market environment, the balance of production and consumption can be freely achieved through price adjustment. If there are too many exports (overproduction) and the foreign exchange supply exceeds the demand, the exchange rate will fall (the domestic currency appreciates), which means that the foreign exchange earned by the export sector can be exchanged for less domestic currency, and the enthusiasm for export will decline, thereby reducing the foreign exchange supply.

If there is strong domestic demand for foreign goods and the foreign exchange earned from exports cannot meet the demand for imports, then competition will cause people to use more of their own currency to exchange for foreign exchange (the domestic currency will depreciate), which will encourage exports and thus increase foreign exchange.

The competition between these two processes makes the market tend to a state of equilibrium. There will never be too much or too little foreign exchange.

But we all know that the Chinese government implements foreign exchange controls. When the government gets involved, the foreign exchange market is completely different. The government interferes with the exchange rate for its own purposes (these purposes are often described as benign, such as increasing exports and limiting inflation), preventing the exchange rate from expressing normally with the market. When the market needs more foreign exchange, the free market would encourage exports by devaluing the domestic currency, but with the government involved, the government forced to sell its foreign exchange to maintain the exchange rate of its own currency, which limits the enthusiasm of export companies.

For example, when foreign exchange is overvalued (for example, the US dollar is too expensive), the free market will show that it cannot consume so much foreign exchange, and foreign exchange will depreciate (that is, the domestic currency appreciates), which will encourage domestic purchases of foreign goods and services. But if the government is involved, the government will say that the market cannot consume, so I will consume it. The government will force the purchase of a large amount of foreign exchange, which will reflect the increase in the government's foreign exchange reserves. This limits the enthusiasm of domestic purchases of foreign products and services.

Where does the Chinese government’s foreign exchange reserves come from?

Before August 2008, China had mandatory foreign exchange settlement and sale, meaning that Chinese people were not allowed to hold any foreign exchange. If you wanted to use US dollars, you had to go to a bank designated by the Foreign Exchange Control Bureau and exchange them for RMB at the official price. If you earned US dollars from exports, the authorities would force you to go to a bank and exchange them for RMB.

Now that compulsory foreign exchange settlement and sale have been cancelled, enterprises and individuals can hold foreign exchange voluntarily (individuals have a foreign exchange holding limit of US$50,000).

But why can the Chinese government still get so much foreign exchange reserves? Why are Chinese companies and people unwilling to hold foreign exchange? There are three main reasons. First, the interest rate of foreign exchange deposits is much lower than the interest rate of RMB deposits. Second, in recent years, the RMB has been appreciating against the US dollar (from 8 to 6). Third, there is a limit on the amount of personal foreign exchange exchange.

But China's foreign exchange reserves have been declining in recent months because the renminbi is on a depreciation channel against the US dollar.

Chapter 7 The Dangers of Government Intervention in Exchange Rates

I am a free market advocate and I believe that the government should stay away from the market, including the foreign exchange market. Government intervention in exchange rates has at least the following major hazards.

1. Create a large trade surplus or deficit. If the market is allowed to adjust freely, a country will not have a situation where net exports exceed net imports. The reason is very clear. Why would I exchange the goods I worked hard for for a pile of paper money? Paper money, especially foreign paper money, is not wealth. I sell my labor to exchange for wealth. Since I have exchanged your paper money, I must exchange it for other goods or services. It is even more impossible to have a large trade deficit. People from other countries are stupid. You take a pile of paper money and exchange it for their goods and services?

But in recent decades, China has had a large trade surplus, which means we have received a lot of dollars, or in other words, a lot of IOUs. The Americans gave us some IOUs, and we sent goods and services to the United States. What's even more abominable is that our government exchanged these IOUs for U.S. Treasury bonds. Originally, we could have exchanged these IOUs for their planes and software from the Americans at any time, but we could have exchanged them for Treasury bonds. Sorry, there is a time limit, and you can't exchange them at any time. Isn't this just stupid?

2. It hinders the development of trade and global division of labor and cooperation. Through the free market, the relative advantages of resources and people of various countries can be maximized. As a result, the government distorts the price, which is the vane of resource allocation, through exchange rate control, leaving enterprises and people at a loss or going in the wrong direction.

Importers are unable to freely choose markets and goods based on price indicators, which means that domestic people cannot buy the cheapest goods, or even good foreign goods.

Exporters are unable to freely choose markets and commodities based on price indicators, which makes it impossible to allocate domestic resources and labor in an optimal way to meet international market demand.

3. Leaving foreign exchange to the government is inefficient. The most important means for the government to intervene in the exchange rate is to accumulate a large amount of foreign exchange reserves and turn them into sovereign funds. The government has never considered market factors when buying things. If the people are allowed to decide how to spend foreign exchange, it will be more efficient.

4. Introducing inflation. Where does the government's foreign exchange reserves come from? They are bought from export companies and the people. But what are they bought with? They are printed. Export companies exchange goods for US dollars, and exchange them all to the government. The government prints a lot of RMB for companies. When companies exchange RMB for US dollars at banks, the banks will not burn these RMB. It would be strange if there is no inflation in the country.

Chapter 8: Hiding Money among the People through Bitcoin

Can trade between countries bypass government exchange rate controls and allow the market to accurately discover international prices on its own?

In the case of sovereign currencies in all countries, it is difficult, because the government controls the central bank, and they can always use some monetary means to collect benefits from their own people and foreign people. Currently, all governments in the world do this, including the United States.

But we currently have a way to bypass the central bank and freely exchange currencies of various countries - using Bitcoin as the medium for exchange.

With Bitcoin, at least we don’t need to rely on the State Administration of Foreign Exchange and its designated banks to settle and sell foreign exchange. We can freely exchange the currency of any country we need, as long as that country has a Bitcoin market. Now the Bitcoin market in mainstream countries in the world has a certain depth.

What are the benefits of settling and selling foreign exchange through Bitcoin?

1. By bypassing the administrative intervention of the State Administration of Foreign Exchange and its designated banks, international trade can be carried out freely. We no longer need to purchase foreign exchange from banks or report the movement of funds to the US Financial Bureau to do business with each other.

2. Save the cost of foreign exchange settlement and sale. Using Bitcoin as a medium for foreign exchange transactions eliminates the need for a clearing system between various banks. Just like using Bitpay for transaction settlement, the transaction fee is only 1%, which is lower than the credit card usage fee used in a country.

3. Under the premise that the Bitcoin market is deep enough, there is no need to care about the fluctuation of Bitcoin prices or the technical threshold of Bitcoin. At present, the biggest obstacle to the widespread use of Bitcoin is that its price fluctuations relative to various legal currencies are too large. However, the hedging of Bitcoin and various legal currencies and the existence of market makers can allow users to ignore such fluctuations and transfer the risk of fluctuations to operators such as Bitpay.

4. Discover the price of currencies more freely and intuitively. Using Bitcoin as a medium to settle and sell foreign exchange is a free market, and all participants use the price formed by the free market as an indicator. Although the foreign exchange administration bureaus of various countries are still influencing the exchange rate, in countries with sufficient Bitcoin market depth, the price of Bitcoin against various legal currencies can reflect the foreign exchange manipulation of various countries. For example, this week, the RMB plummeted, the exchange rate between Bitcoin and the US dollar was basically stable, but the price of Bitcoin against the RMB was rising.

5. With Bitcoin, any foreign exchange management method set by the State Administration of Foreign Exchange can be circumvented. We can freely use Bitcoin to exchange for US dollars in the United States, exchange for euros in the European market, and exchange for RMB in the Chinese market. We can freely hide the exchanged US dollars under the bed, deposit them in overseas accounts, or buy foreign financial products.

Chapter 9 Conclusion

Bitcoin is a product that defies nature, defying the "sky" formed by the government that covers the free market. I wish Bitcoin to thrive and succeed in defying nature soon.

The topic of RMB exchange rate is very hot this week, so I hurried to supplement my foreign exchange knowledge. I don’t know if the information I have consulted is sufficient, and whether my understanding is wrong. I hope readers will understand. If there is any mistake, please don’t be angry, and it’s best not to scold me. Leave a message to tell me, I will thank you.

Thank you for the tip in the previous article, Gann-Dogecoin, the owner of the anonymous address 1BcKgEm1862LBbsp9kG49P5HgBojL4qAVF, Martian, and lonely stranger. Thank you for your encouragement.