Study On China's Foreign Exchange Reserve Institutional Innovation

Foreign exchange reserve (FER) is an integral part of international reserve. As an important national large state-owned external public reserve fund, international reserve is used to meet the ends of international balance of payments, maintain the stability of currency exchange rate, guarantee credits and pay all sorts of emergency situations, which is generally accepted by the world as assets and external claims, owned by the monetary authorities of a country. The current international reserve assets generally include monetary gold, foreign exchange, reserve position at the International Monetary Fund (IMF), Special Drawing Rights (SDR) and so on. FER refers to a variety of reserve assets which can be freely converted.FER has become the most important part of our national international reserve assets. According to the data published by China's State Administration of Foreign Exchange Website, up to the end of 2008, our national international reserve assets include 19.29 million ounce of gold reserve, 1946.03 billion USD of FER. According to London Gold Market 833 USD per once of gold on January 19th, 2009, 19.29 million ounce of gold is worth 16.069 billion USD, which accounts for0.83% of our national FER. Even considering the facts that we have 136.447 million USD reserve position at the IMF, 66.416 million USD SDR up to June, 2008, the proportion of FER in the total international reserve assets has been up to 99.17%.The international reserve institution and China's FER institution have experienced a relatively long history of development and change. The international reserve institution can be traced back to the 16th century, called silver-based reserve system, in which silver is treated as the reserve asset. As an international public commodity, one of the most important reasons which lead to its emergence and development is the conflict between the independence in nation's politics as well as sovereignty, and the relevance in economy development as well as trade around the world. In order to reduce risks and uncertainties in international economic transactions, cut transaction costs as much as possible, and promote smooth international trade and international capital flows, association and coordination are required. So, as rules, practices, policies, mechanisms as well as institutional arrangements, an international monetary institution and its subordinate part, an international reserve system were born to regulate international payment, clearing, exchange rate, and so on. The initial international reserve institution was based on something axiomatic, such as custom, which was a non-mandatory institution and convention. However, with the circulation of commodities and currency developing and changing, at the end of World War II, metal monetary system was replaced by the credit monetary system, because of the world's uneven distribution of gold, the expansion of international trade, limited storage of gold as mineral resources, and so on.After consultation and coordination, just as Commons stated,"collective action controls individual action", a new cooperation mechanism was set up artificially. They are the Bretton Woods system and the Jamaica international reserve system, the latter of which started from the 1970s in the twentieth century and is still in use today. China's FER institution was established in the early founding of the country. During decades of institutional change, property right incentive, state supply and association with the economic system have become the main factors of China's FER institutional change. It has the characteristics of mandate, dependence and hysteresis.There is a serious disequilibrium in the current China's FER institution. It includes that China has a quantity of excess FER, there is about 65-70% USD assets in total FER assets, there is a relative single organization setting named State Administration of Foreign Exchange, FER has been misappropriated, etc. These facts reflect that China's FER institution is serious disequilibrium.First, since we have not yet promulgated a special legislation on FER management, the result is that the use and management of FER has no legal basis, which has seriously affected the integrity of China FER assets. Second, there are sharp contradictions between the institutional demand and institutional supply of China's FER institution. There not only exists institutional supply shortage, but also excess. Institutional supply shortage reflects that in the existence of institutional demand, institutional supply is lagging behind demand. Institutional supply excess refers that institution has completed its mission but it did not quit and still plays a role. The result is that it causes China's FER institution non-Pareto optimal, high institutional costs, and mass existence of"potential profit". Third, there exists a flexible institutional disequilibrium in China's FER institution, which includes the deficiencies of FER quantity management system and quality management. Obviously, China's FER institutional construction is incompatible with its status as world's first FER country.The consequence of disequilibrium of China's FER institution is serious. On the macro level, first, it has seriously affected the integrity of the FER assets. Since we do not have a specialized FER legislation, we lack mandatory institutional binding. It may cause contrary to the exclusive use of reserve assets, misuse and misappropriation of FER assets. Second, it threatens the stability of currency circulation and weakens the independence of monetary policy. The rapid growth of FER leads to over-running of the base currency, which forces the central bank to implement passively a tight monetary policy. Third, it restricts the process of the internationalization of RMB. At present, there is no foreign exchange stabilization fund, which is designed to readjust foreign exchange market and maintain the stability of foreign exchange rate. It may cause the lack of institutional guarantee to maintain RMB exchange rate after its market-oriented reforms. Fourth, the maintenance of large FER also means the actual resources are not effectively used. The existence of excess FER is a waste of resources.On the micro level, first, it increases the complexity of FER management. As the scale of FER assets grow larger, the difficulty of management becomes more difficult. Second, it increases the difficulty of measuring and controlling risk. Because of high amount of FER, complexity of currency and asset structure, frequent fluctuation in currency exchange rate, measuring and controlling rick of FER becomes more and more difficult. Third, it increases the cost of holding the reserve. The higher the amount of FER becomes, the higher the opportunity cost, accounting cost and marginal cost will be.China's FER institutional innovation is the optimal choice to solve China's FER institution disequilibrium. The first problem of institutional change and institutional innovation is to study the goal and structure of the new institution, which is more efficient, lower operating costs and higher benefits, so as to replace the old one.Therefore, in the chapter of China's FER institutional innovation, first of all, we describe the goal and model of China's new FER institution, and analyze the objective function and model selection of China's FER institutional innovation. Second, we put forward a specific framework of our national FER institutional innovation, which means to set up a complete system, which consists of a series of independent institutions. In this system, it should generally include a series of institutional arrangements such as legislation institution, organization institution, quantity institution, quality institution, etc.Legislation institution is to maintain the integrity and specificity of national FER assets. Organization institution is to form different organizations to manage FER assets of different functions. Quantity institution is to ensure moderation and rationality of the FER scale. Quality is to preserve the value and increment of the assets. Legislation and organization institution are kind of mandatory institution, while quantity and quality institution kind of institutional arrangements which should have a certain degree of flexibility and a range of flexible changes.China's FER institutional innovation can take the way of partial reform. That is, to adjust and transform partial of the factors or structure of the existing institution, in order to update its functions. As there is still part of institutional value in China's FER institution, it is more applicable to take the way of partial reform.The institutional innovation of partial reform is a kind of improvement, which causes relatively small social turmoil and is more suitable for the way that Reform-and-Opening-up requires, which is a way of from-outside-to-inside and from-partial-to-overall. The ultimate goal of this paper is to promote a equilibrium to China's FER institution, improve the management quality of national FER assets, and promote deepening reform to China's FER management system, through innovating and improving China's FER institution.