Study Of The U.S. Treasury Security’s Effects On RMB Exchange Rate

In the circumstance of global financial crisis, as to cope with the shockeffectively, the U.S. applied extremely loose monetary policy to push the benchmarkinterest rate down to extremely low level, and also used fiscal tool actively to expandthe scale of the public deficit. As for the monetary policy, the Federal Reservepurchased massive treasury securities, as to inject liquidity into the real economy. Asfor the fiscal policy, due to the worsening of economy, the tax revenue was alsonegatively influenced. So the U.S. issued massive treasury securities to acquirefunding, and to cover the huge deficit gap. Obviously, the issue of U.S. treasurysecurity is a key factor to U.S. economic recovery, and would affect some majoreconomic and financial variables, like money supply, interest rates and finallylong-term trend of the U.S. dollar index. Meanwhile, with the increasing economicties between China and the U.S., the scale of China holding U.S. treasury security alsopresents a fast growing tend. At present, China had become the largest U.S. treasurysecurity holding country, and the changes in the holding scale would affect the RMBinterest rate through the changes of China foreign exchange reserve assets. Therefore,with the uncertainty of world economy recovery, especially the continued spreadacross of sovereign debt crisis, research and study the U.S. treasury security’s effecston RMB exchange rate is not only beneficial for taking precautions for the financialshock of U.S. treasury security issue, offering theoretical and realistic basis for RMBexchange rate mechanism reform, but also providing useful reference for furtherperfecting the foreign exchange reserves investment in the strategic environment ofRMB internationalization.According to the analysis of transmission channels, the U.S. treasury security’seffect on RMB exchange rate includes two ways as U.S. issue scale and Chinaholding scale. In the U.S. issue scale side, it could be divided into money purchasingpower and market interest rate ways. In the China holding scale side, it is mainly fromthe supply and demand of the financial asset channel. Firstly, the expansion oftreasury security will enlarge the money supply, reduce the value of local currency inforeign exchange market, devaluate the local currency. Secondly, when U.S. expandsthe debt scale, domestic interest rate will increase. In short term, investors buy localcurrency and upvalue local currency. But in long term, after the arbitrage, investorssell local currency to take the profit, and devalue local currency. Thirdly, treasury security is a risk free financial asset, and also the benchmark in investment portfolio.Change in treasury security’s price will cause change in the demand of local currency,and influence exchange rate of local currency.This paper examined and analyzed U.S. treasury security’s effects on RMBbilateral exchange rate and real effective exchange rate.At the beginning, the author examed the effects of U.S. treasury security issue onRMB exchange rate. Empirical study based on VAR model and VECM model showsthat, the U.S. treasury security has important direct influence in the process of the twokinds of RMB exchange rate changes. The expansion of U.S. treasury security issuewill cause increase of RMB bilateral exchange rate, but the RMB real effectiveexchange rate appears two-way fluctuations. Further studies have shown that the U.S.treasury security can also affect RMB exchange rate, through the influence of moneysupply, market interest rates and other related economic variables. Since the RMBexchange rate mechanism reform in2005, adjustments of economic variables havesignificant strengthening in change of RMB bilateral exchange rate, but relativelyweak effect in change of RMB real effective exchange rate. Such as, the U.S. moneysupply has obvious function in predicting RMB real effective exchange rate, butinsignificant effect in predicting RMB bilateral exchange rate; short-term interest ratehas significant effect in predicting RMB bilateral exchange rate, and long-terminterest rate shows better in predicting RMB real effective exchange rate.In the middle, the author examed the effects of China holding U.S. treasurysecurity on RMB exchange rate. Empirical study based on SVAR model shows that,China holding U.S. treasury security has more shock contribution on RMB realeffective exchange rate than RMB bilateral exchange rate. From the RMB exchangerate mechanism reform in2005to the break out of the global financial crisis,comparing to the scale of China holding U.S. treasury security, change of RMBexchange rate is more effected by the yield of U.S. treasury security. Between thebreak out of financial crisis and the second RMB exchange rate mechanism reform inJune2010, RMB exchange rate changes slightly, because the exchange ratemechanism is pegged to U.S. dollar, the scale of China holding U.S. treasury securityand the U.S. treasury security yields do not take much influence on the change ofRMB exchange rate. After the restart of RMB exchange rate mechanism reform, withweak recovery of global economy in risk and uncertainty, factors of U.S. treasurysecurity have stronger shock on the change of RMB exchange rate, and the scale of China holding U.S. treasury security take particularly significant influence in dynamicadjustment of RMB exchange rate.At last, author examined the combined effect of U.S. treasury security issue andChina holding. Empirical study based on vector auto regression model and Scenarioanalysis shows that: Firstly, the expansion of U.S. treasury security scale will increaseRMB bilateral exchange rate, but the RMB real effective exchange rate decrease afterthe increase in beginning. China increase scale of holding U.S. treasury security hascontinues effect on increase of RMB bilateral exchange rate and decrease of RMBreal effective exchange rate. Secondly, U.S. treasury security issue has more shockcontribution on RMB real effective exchange rate than on RMB bilateral exchangerate. China holding U.S. treasury security has more shock contribution on RMBbilateral exchange rate than on RMB real effective exchange rate. Thirdly, in thesituation of continues U.S. treasury security issue and China increase holding scale,the RMB real effective exchange rate, as pegged a basket of currencies, caneffectively absorb shock of change in U.S. treasury security issue, and be beneficialfor the stabilization of RMB value.As to conclude, with continues expansion of U.S. treasury security issue andincrease of China holding U.S. treasury security, we need to consider change in U.S.treasury security as an impartment indicator in predicting RMB exchange rate, securethe direction of RMB exchange rate mechanism reform, moderately control the scaleof holding U.S. treasury security, constantly optimize the foreign exchange reservesstructure, so as to reduce the shock to RMB exchange rate from U.S. treasury securityand other external factors.