RMB surpasses 72 against the USD, reaching a new high since August What happened? What is the future trend?

AI Briefing Offshore RMB surges nearly 200 points against the US dollar, reaching the threshold of 720 Prior to this, the midpoint rate of RMB against the US dollar was raised to its highest level since August, with an increase of 116 points, settling at 71612 Offshore RMB hitting the 720 mark achieves a new high since August

Offshore RMB breaks through the 7.20 level

Providing more information for our friends:

Just now, the offshore RMB surged during trading! What’s going on with the exchange rate against the US dollar breaking through 7.20?

Edited by Li Zedong at Every editor.

Following the onshore market, the exchange rate of the RMB against the US dollar has also broken through the 7.20 level in the offshore market.

On November 20th, the offshore RMB exchange rate against the US dollar broke through the 7.20 level during trading. This is the first time it has broken through this level since August 8th, with a rate of 7.18925 at the time of writing.

In terms of news, on November 20th, the one-year loan prime rate (LPR) was quoted at 3.45%, the same as last month; the LPR for terms longer than one year was quoted at 4.2%, also the same as last month.

Huaxi Securities research report believes that with the decline in US inflation and weakening of the US dollar index, the market continues to trade on the view that “the Fed’s interest rate hikes are over” and global risk assets are taking a breather. The current exchange rate of the RMB has returned to the level of August, and the constraints of exchange rate depreciation on monetary policy have clearly eased, increasing the possibility of foreign capital returning to net inflows and helping to maintain the trend of A-share market at the end of the year.

Huaxi Securities also mentioned that the central bank is actively safeguarding macro liquidity, and with the easing of RMB depreciation pressure, the space for domestic monetary policy has opened up. Last week, the central bank conducted 1.45 trillion yuan in medium-term lending facility (MLF) operations, with a net injection of 600 billion yuan, reaching a new high for the year. At the same time, market expectations for required reserve ratio cuts have declined. The loose tone of domestic macro policies has not changed, and subsequent efforts in loose fiscal policy require coordination with monetary policy. With the weakening of the US dollar index, the current exchange rate of the RMB has returned to the level of August, and the constraints of exchange rate depreciation on monetary policy have clearly eased, making it possible for macro liquidity to remain relatively abundant.

According to Guojin Securities research report, since November 1st, the onshore and offshore RMB has appreciated by 1.4% and 1.6% respectively, while the US dollar index has significantly weakened by 2.7%, which is an important driver behind the appreciation of the RMB exchange rate.

Guojin Securities pointed out that the rapid weakening of the US dollar is the direct driver behind the appreciation of the RMB exchange rate, while the rapid decline in US bond yields is the main reason for the weakening of the US dollar. Under the combined impact of a marginal easing in the supply side shock of US bonds, weak economic data, and alleviation of speculative disturbances, US bond yields have rapidly declined and the US dollar index has consequently weakened. The derivatives market has released positive signals, and market behavior has started to marginally improve the strength of forward exchange rates and lower the factors of risk reversal, which have all signaled the continuation of RMB appreciation.

According to the Shanghai Securities News, Wang Chunying, Deputy Administrator of the State Administration of Foreign Exchange and spokesperson, said recently that in the future, as various domestic policies are implemented precisely and effectively, positive factors will continue to accumulate, and the support of the economic fundamentals for the foreign exchange market will be further consolidated.

At the same time, in recent years, the depth and breadth of China’s foreign exchange market have continued to expand, the participating entities have become more mature, trading behaviors have become more rational, and macro-prudential management tools have become more complete, overall enhancing the ability to withstand external shocks. In addition, the market generally believes that the Fed’s interest rate hike cycle is nearing its end, and the spillover impact on the international financial market will ease. With the continuous improvement of the internal and external environment, China’s foreign exchange market and cross-border capital flows are expected to continue to operate smoothly.

Comprehensive information from Shanghai Securities News and public sources on Daily Economic News

Exchange Rate Formation Mechanism

It is better to teach someone to fish than to give them a fish.

The important thing is not a few specific conclusions, but the method of arriving at those conclusions.

If you do not grasp the basic methods and principles, you will be puzzled by why the exchange rate goes up today and why it goes down tomorrow.

In this article, I will explain the transmission process of the current exchange rate of the Chinese yuan, clarify the basic principles, and let everyone make their own judgments.

Regarding the formation of exchange rates, the current mainstream view is as follows: (1) The core factor influencing the formation of exchange rates is international balance of payments. (2) The fluctuation of the US dollar index is the main external factor affecting the exchange rate of the yuan. (3) The management of the central bank also plays a role in the exchange rate.

01 The Relationship between International Balance of Payments (Foreign Exchange Reserves) and Exchange Rates

The core factor determining the exchange rate of the Chinese yuan is the country’s international balance of payments, which includes the balance of payments of the current account and capital account, and this balance is reflected in the change in foreign exchange reserves.

The exchange rate itself is determined in the process of currency exchange, so a country’s international balance of payments (whether it has a surplus or a deficit) is the most crucial factor determining the exchange rate. International balance of payments mainly includes the current account (which can be simply understood as trade) and the capital account (which can be understood as investment). Let’s take the current account as an example to illustrate how international balance of payments affects the exchange rate.

Suppose you have a company and your company needs to pay a payment of 1 million US dollars to a company in the United States after one month. You approach your bank, Bank A, and ask them to pay 1 million US dollars to your overseas customer on your behalf. Bank A quotes you a price, which is 6.7325 million Chinese yuan to purchase 1 million US dollars, and you agree to the transaction. At this time, there is an exchange rate, which is 1 US dollar to 6.7325 Chinese yuan. We can consider this exchange rate as the “retail” exchange rate, and the market formed by this exchange rate is called the “retail market,” which is the market between banks and customers.

Due to various reasons (such as insufficient foreign exchange reserves), Bank A will also buy foreign exchange from other banks or non-bank financial institutions. This transaction market is called the interbank market. The exchange rate in the interbank market is generally more favorable, and the price difference between the interbank market and the retail market constitutes part of the bank’s income. For example, Bank A purchases 1 million US dollars with 6.7125 million Chinese yuan, earning a price difference of 20,000 yuan. In this case, there are two markets, two exchange rates. Which exchange rate do we usually refer to when we talk about the exchange rate? Generally speaking, the exchange rate we often refer to is the exchange rate formed in the interbank market.

Conversely, if your company receives foreign exchange income, such as 1 million US dollars, you can also sell it to your bank. Your bank can also sell these US dollars in the interbank market to earn the price difference.

A country with a trade surplus is a net inflow country of foreign exchange reserves (considering only the current account). In this case, it can be simplified as follows: (1) More and more domestic companies earn US dollars and sell them to banks (buying Chinese yuan with US dollars). (2) As the buying of Chinese yuan with US dollars increases, the Chinese yuan becomes more in demand and more expensive (for example, in the past, 100 US dollars could buy 700 Chinese yuan, but now it can only buy 680 Chinese yuan), and the exchange rate of the Chinese yuan rises.

Because international balance of payments has two components, one related to trade and the other related to capital, a trade surplus (i.e. the current account) alone cannot reflect the full picture of international balance of payments. For example, a country has a strong export industry and has a trade surplus of 10 billion US dollars, but the country’s enterprises have invested all of this 10 billion US dollars overseas, resulting in a capital account deficit of 10 billion. In this case, the international balance of payments is balanced. The international balance of payments considers the balance of payments of both the current account and the capital account, and the balance of international balance of payments corresponds to the increase or decrease in foreign exchange reserves.

Therefore, we can simply understand that if a country’s foreign exchange reserves continue to increase, the exchange rate will continue to rise.

02 Interest Rate Arbitrage and the Change in China’s Foreign Exchange Reserves Since August

In August, China’s foreign exchange reserves fell by $44.2 billion, half of which was due to adjustments in exchange rates and interest rates, usually caused by US interest rate hikes. Let me explain briefly.

Foreign exchange reserves are usually held in foreign government bonds and need to be priced in US dollars. In August, the euro, yen, pound, and other currencies depreciated, leading to a contraction of China’s foreign exchange reserves. In addition, since foreign exchange reserves are mostly held in foreign government bonds, and the price of government bonds is inversely proportional to interest rates, when interest rates rise, the price of government bonds will fall. In August, the bond yields of the euro, dollar, yen, and pound were all rising, which caused a corresponding decline in our foreign exchange reserves.

The changes in exchange rates and interest rates led to a contraction of 20 billion US dollars in China’s foreign exchange reserves. Another 20 billion US dollars was due to the impact of US interest rate hikes, which led to a significant outflow of capital. Why would an interest rate differential lead to capital outflows? Let me give you an example to illustrate.

Let’s say you are a billionaire with $1 billion in liquid funds that need to be deposited in banks. Let’s say at the beginning of 2020, the deposit interest rates in the UK and the US are both 1% per year. For you, it doesn’t matter whether you deposit your money in the UK or the US, as the annual interest for both countries is $10 million. Adhering to the principles of fairness and justice, you deposited $500 million in the US and $500 million in the UK (equivalent in pounds).

One day, the Federal Reserve announced an interest rate hike, resulting in a higher deposit interest rate in the US of 3%. You realized that this won’t work. With $500 million deposited in the UK, you would only earn $5 million in interest for a year, while with $500 million deposited in the US, you would earn $15 million, resulting in a $10 million interest rate differential. You called your secretary and instructed them to inform the UK bank that you want to withdraw all your money, convert it into dollars, and transfer it to a US bank.

Not only did you notice this arbitrage opportunity, but many large investment institutions also discovered this arbitrage opportunity. So, these large investment institutions obtained low-interest loans from UK banks and deposited the funds in US banks to earn the interest rate differential. This process is called “interest rate arbitrage,” which is an important factor causing capital outflows.

Some friends say that we have capital controls and cannot engage in interest rate arbitrage. This is not correct. It may be difficult for ordinary individuals to engage in arbitrage, but large institutions have various channels to withdraw funds. The latest report from Shenwan Hongyuan pointed out, “The difference between the ten-year government bond yields of China and the US reached a downward trend of 22 basis points to -1.53% in August, and even reached a low of -1.80% at one point in the month, resulting in a outflow of funds sensitive to the China-US interest rate differential.”

03 Interest Rate Arbitrage (Inverted Yield Curve) and the Decline in the Exchange Rate

Interest rate arbitrage leads to capital outflows, which in turn can cause the outflow country’s exchange rate to decline. Why is that? Let me give you an example.

Suppose you are the head of a large investment institution, and you have discovered a significant interest rate arbitrage opportunity in the financial markets of the UK and the US. So, you borrowed 1 billion pounds from a UK bank at a low-interest rate, intending to invest it in the US to take advantage of the interest rate differential.

However, you have pounds in your hand, and if you want to deposit pounds in a US bank, you cannot enjoy the interest on the dollars, as bank interest rates are tied to specific currencies. In other words, before depositing pounds in the US, you need to convert your pound holdings into dollars. This process is called foreign exchange trading.

More and more people are borrowing pounds from UK banks at low-interest rates and buying dollars in the foreign exchange market. The US dollar becomes more and more in demand and attractive. Previously, 100 pounds could buy 120 dollars, and now 100 pounds can only buy 110 dollars. The US dollar becomes more and more “expensive,” while the pound becomes cheaper, reflecting the depreciation of the pound against the dollar.

In fact, since the US interest rate hike, major currencies around the world have started to depreciate. This is also an important reason for the current decline in China’s exchange rate. The US interest rate hike and China’s interest rate cut have widened the interest rate differential, creating a larger space for interest rate arbitrage, which leads to capital outflows and consequently a decline in China’s exchange rate.

04 Impact of the US Dollar Index

Against the backdrop of the worsening international balance of payments, if the US dollar index strengthens, it will further lead to a decline in the exchange rate and cause volatility in the capital market. Let me give you an example.

Suppose you have a company that earns $1 million in foreign exchange at a certain point in time, but do you necessarily want to sell it to the bank immediately? The answer is no. For example, if the US dollar is strong and you expect that two months later, the exchange rate of the US dollar to the Chinese yuan will rise from 1:6.7 to 1:6.9. You would not immediately buy Chinese yuan with your US dollars, but you would hold onto the US dollars, wait for the right timing, as now, if you exchange, you can get 6.7 million, whereas in two months, you can get 6.9 million.

In this situation, although there is a surplus of $1 million in international balance of payments, it does not enter the foreign exchange market through banks' sale and purchase of foreign exchange, because the appreciation expectation of the US dollar leads companies to hold onto their foreign exchange, and even though there is a surplus in the international balance of payments, it does not directly cause an increase in the value of the Chinese yuan. Or conversely, it slows down the upward trend of the Chinese yuan exchange rate.

Internationally, the strength or weakness of the US dollar is judged by the US dollar index. The US dollar index is a weighted average exchange rate of six currencies against the US dollar (with the euro accounting for 57.6%), reflecting the exchange rate of the US dollar against major currencies.

A strong US dollar index leads to an expectation of depreciation of the Chinese yuan and reduces the desire of enterprises to sell US dollars. Therefore, it further strengthens the possibility of depreciation of the Chinese yuan, forming a downward spiral.

Moreover, a strong US dollar resulting from the interest rate hike also triggers volatility in the capital market. To understand this issue, let’s immerse ourselves in an example.

Suppose you are an international investor holding US citizenship, and your funds are allocated in major global stock markets. Let’s assume that in early 2022, the exchange rate between the pound and the US dollar is 1:1. Through research, you found that the UK stock market may experience a wave of bullish trends. So, you spent $1 million to buy 1 million pounds and then used the 1 million pounds to purchase stocks in the UK stock market. Your insight was correct, and the stocks you bought performed well, rising to 1.2 million pounds in a few months, making you very happy.

But unexpected events can happen, and one day, you suddenly see the news that the US is raising interest rates. You immediately realize that this could be bad news. As expected, those speculators relying on interest rate differentials started to take action. They borrowed a large amount of pounds at low interest rates and bought US dollars. The US dollar kept appreciating, and the pound kept depreciating. Suddenly, you realized that the money you earned from stocks was all on paper. You carefully calculated and found that from the beginning of 2022 until now, the pound has depreciated against the dollar by 15%. Your 1.2 million pounds can only be exchanged for 1.02 million US dollars, approaching your cost.

What’s even more horrifying is that the Federal Reserve continues to raise interest rates, which means that the trend of pound depreciation may continue. If this continues, your stocks, when converted into dollars, will result in a loss. So what do you do? You tell yourself that you need to make a decisive move. Thus, you start selling stocks on a large scale, converting them into cash, and buying US dollars as a “safe haven.”

More and more people discover this issue, and they also start selling stocks. The stock market starts to reverse, negative news keeps coming, and when most people are selling, two phenomena occur: (1) A large number of sell orders leading to market volatility. (2) A large outflow of funds further intensifies the decline in the exchange rate.

Historically, the US dollar index has a high correlation with China’s exchange rate.

If a country’s capital market is already unstable, capital outflows will happen faster.

Conversely, a weak US dollar will generally lead to a stronger exchange rate for the Chinese yuan.

05 Under What Conditions Can the Chinese Yuan Rebound

We are also concerned about when the Chinese yuan can stabilize.

Central bank policies can have some short-term effects. For example, when the exchange rate depreciation was significant, the central bank reduced the foreign exchange deposit reserve ratio, which means that less reserve requirements are needed for each foreign exchange deposit. This increases the amount of foreign exchange available for circulation, increases the supply of foreign currency in the foreign exchange market, and supports the exchange rate of the Chinese yuan. The central bank has various tools at its disposal, and the simplest and most direct method is to directly use foreign exchange reserves to purchase Chinese yuan to support the exchange rate.

However, in the medium to long term, the core of the stabilization of the Chinese yuan lies in an improvement in the international balance of payments. The conditions for improving the international balance of payments are as follows: (1) A significant rebound in net exports, rapid growth in trade surplus, resulting in an increase in foreign exchange reserves. (2) The revitalization of China’s asset markets, a significant increase in domestic asset returns, attracting foreign capital inflows, and increasing foreign exchange reserves.

Of course, if the US dollar weakens, it is possible for the Chinese yuan to strengthen. However, whether it can strengthen still depends on the aforementioned conditions, as the exchange rate is influenced by multiple factors and not a single factor.

This article is an excerpt from the “Exchange Rate Formation Mechanism” and is fully published in “Zoe’s Reading Circle.” You are welcome to join “Zoe’s Reading Circle” to learn together with hundreds of star friends from all walks of life, progress together, see more paths, and make fewer mistakes.

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1. Inflation, Interest Rates, Exchange Rates, and Monetary Policy

  1. On July 8, the judgment that the US interest rate hike would cause further depreciation of the Chinese yuan:

  2. On July 10, the judgment that the US interest rate hike would put pressure on the exchange rate:

  3. On July 11, information from The Economist on the impact of the US labor market on interest rate hikes:

  4. On July 19, the judgment that there would likely be an interest rate cut and reserve requirement ratio cut in the third quarter:

  5. On July 29, information sharing on the upward pressure on inflation caused by the continuous rise in oil prices:

  6. On August 11, an explanation of the analytical method, discussing the exchange rate formation mechanism:

  7. On August 30, an article sharing that interest rate differentials and the basic balance led to the possibility of further downward adjustment of the Chinese yuan exchange rate:

  8. On September 10, a review of the logic behind the decline in the Chinese yuan exchange rate:

  9. On September 15, the support of rising oil prices and the pressure on the US to raise interest rates:

  10. On October 6, an analysis by Bloomberg on the various impacts of high interest rates on the economy:

2. Real Estate Related Issues and Information

  1. How much will house prices decrease:

  2. Can house prices continue to hold up:

  3. Pricing model for future house prices:

  4. In-depth report on the impact of current real estate policies:

  5. Analysis report on real estate vacancy rates:

  6. Analysis of real estate default risks:

  7. Stress test on the impact of a real estate collapse on banks:

  8. Full analysis of the real estate industry chain:

  9. Impact of demographic changes on real estate:

  10. A review of the real estate industry’s first-half data:

3. Fundamental Judgments

  1. Are we experiencing deflation or inflation:

  2. Goldman Sachs' “Impossible Trinity”:

  3. De-dollarization and international currency change:

  4. Review of global economic performance in the first half:

  5. Where has residents' money gone:

  6. Insights into local government debt from frontline personnel:

  7. Interpretation of the July meeting, how to judge the current economic situation:

  8. How to view the current decline in consumption:

  9. Global overcapacity status:

  10. Analysis of the impact of trust defaults on the economy according to an article from the Financial Times:

4. Analytical Methods for the Economy

  1. Why tax reductions lead to reduced savings:

  2. Understanding the inventory cycle:

  3. Understanding M0, M1, and M2:

  4. The relationship between central bank balance sheet expansion, new social financing, and M2 growth:

  5. How to analyze credit and financing data:

  6. How to analyze PMI data:

  7. How to analyze total industrial enterprise profits:

  8. The impact of narrowing interest rate spreads on deposit rate cuts:

  9. Is the issuance of the Chinese yuan based on the US dollar or land:

  10. Recent report from the Financial Times on how to invest in a high-interest rate environment:

5. Conditions for Rebound

  1. The policies of the central bank can have some short-term effects. For example, in the past, when there was significant depreciation in the exchange rate, the central bank reduced the reserve ratio for foreign exchange deposits, which means that less reserve is required for each foreign exchange deposit, increasing the amount of foreign exchange in circulation, and increasing the supply of foreign currency in the foreign exchange market, which supports the exchange rate of the Chinese yuan. The central bank has various tools, and the simplest and most direct way is to directly use foreign exchange reserves to purchase Chinese yuan to support the exchange rate.

However, in the medium to long term, the core of stabilizing the Chinese yuan lies in improving the international balance of payments. The conditions for improving the international balance of payments are as follows: (1) A significant rebound in net exports, rapid growth in trade surplus, leading to an increase in foreign exchange reserves. (2) The revival of China’s asset markets, a significant increase in domestic asset returns, attracting foreign capital inflows, and increasing foreign exchange reserves.

Of course, if the US dollar weakens, it is possible for the Chinese yuan to strengthen. However, whether it can strengthen still depends on the aforementioned conditions, as the exchange rate is influenced by multiple factors rather than a single factor.

RMB Appreciation Trend and Future Outlook

The fluctuations in the offshore RMB to USD exchange rate need to be considered from two perspectives.

On the one hand, the recent decline in the US dollar index from about 107 to around 103 naturally reduces the depreciation pressure on the RMB.

On the other hand, our economic data has been increasingly stable in recent months, indicating that the underlying fundamentals of the RMB are stabilizing.

The difficulty of the US raising interest rates is continuously increasing, and the world is predicting when the US will begin to cut interest rates next year.

In this backdrop, it is currently difficult for the US dollar to strengthen, and the exchange rates of various countries against the USD will experience short-term pressure reduction.

With the short-term weakness of the US dollar, our economic fundamentals can stabilize.

For the RMB exchange rate, both pressures are reduced, naturally resulting in a wave of appreciation.

The previous depreciation of the RMB exchange rate to above 7.3 was caused by the strong US dollar and lower-than-expected economic data.

Conversely, it is easier to understand why the RMB exchange rate is now appreciating.

In the future, the RMB will continue to have a trend of mild appreciation due to our GDP exceeding expectations in the third quarter.

In the third quarter, China’s GDP has already achieved a 4.9% growth, and it has also issued 1 trillion yuan of national bonds, which will have an impact of 0.5-0.8% on the overall GDP.

The IMF has immediately raised its forecast for China’s GDP for this year to 5.4%.

It has also raised the forecast for next year’s GDP to 4.6%.

Therefore, as long as next year’s GDP remains stable, the possibility of a one-way depreciation in the exchange rate will not occur.

Furthermore, the announcement of interest rate cuts in Europe and the United States next year will reduce pressure on the exchange rate.

Therefore, the period of the greatest depreciation pressure on the RMB exchange rate in the future has already passed.

Maintaining a long-term trend of mild appreciation poses no major issues.

However, it will not reach below 7 too soon because global economic conditions will still be challenging next year.

During such times, there will certainly be pressure on trade, and a rapid appreciation will be unfavorable for foreign trade.

Therefore, the pace of this mild appreciation will be relatively slow, until there are clear signs of global economic recovery.

And only after Europe and the United States have raised interest rates consistently for a period of time, the RMB exchange rate may rapidly return to below 7.

That’s about the pace of the situation.

The key points are the trend of the US dollar index, the internal situation of our economy, and the state of global trade.

In any case, it will not be a one-way movement, as we have already discussed many times.

It’s just that every time it appreciates a little, some people start shouting “5,” and when it depreciates a little, some people start shouting “8.” It’s all irrational.

The RMB exchange rate should be controlled within a reasonable range, based on the latest situation, and undergo fluctuations accordingly.

Reasons for the appreciation of the Renminbi and its future trend

I just checked and the Renminbi to US Dollar exchange rate has risen to 7.16 yuan. The A-share market has also experienced a wave of upward movement due to the sentiment of the Renminbi strengthening. The morning trading volume reached 578.2 billion yuan, and the net inflow of northbound funds amounted to 1.18 billion yuan.

The recent appreciation of the Renminbi is mainly a result of the violent surge driven by sentiment. There are several reasons for this:

  1. The temporary pause in the interest rate hike by the Federal Reserve will directly undermine the strong support for the US Dollar.

  2. When both currencies maintain extreme fluctuations for a long time, they are easily stimulated by news, leading to large rises and falls.

The following two pieces of news have further contributed to the market sentiment:

  1. On the evening of November 17, the People’s Bank of China, China Banking and Insurance Regulatory Commission, and China Securities Regulatory Commission jointly held a symposium with financial institutions to discuss key tasks such as real estate finance, credit injection, and resolution of financing platform debt risks in the near future. This measure has provided substantial confidence assurance to the market.

  2. The Consumer Price Index (CPI) for October, released on the 14th, showed a slowed year-on-year increase of 3.2%, with core CPI rising 0.2% month-on-month, a 0.1 percentage point decrease from the previous value. The Producer Price Index (PPI) announced on the 15th saw the largest decline in three and a half years. Retail sales in October fell 0.1% compared to the previous month, the first decline in seven months. Signs of a cooling job market have also continued to strengthen. When domestic inflation in the United States is under control, it means that the day for the Federal Reserve to cut interest rates is not too far away.

As for the future trend of the Renminbi? Here is my personal bold speculation.

Currently, the main movement in the market is driven by sentiment, and not by any substantial and sustainable signals of economic transformation. Therefore, in the short term, the Renminbi to US Dollar exchange rate is expected to fluctuate around 7.20 yuan. By the second half of next year, the exchange rate is expected to reach 6.9 yuan. However, even if the Federal Reserve starts to cut interest rates, I conservatively estimate that we will still keep the exchange rate between 6.8 and 7 yuan under control. This is because our current domestic economic cycle is unlikely to drive employment and domestic consumer market demand, and only by vigorously developing foreign trade can we fundamentally change our current predicament.

What do you think? If you have different opinions, feel free to discuss in the comment section.

To grasp the intergenerational replacement of the times, one must understand the rules of economic development orientation in the era.

A small story can also reveal the general trend:

The village chief proposed to build a road. First, he gathered everyone together and promoted the important idea of becoming rich by building the road. Afterwards, he asked everyone to contribute money and effort. However, at this point, everyone was thinking that they had contributed money and effort, but the happiness they would enjoy in the end would be shared by all. They didn’t feel that the benefits to themselves were clear enough, and if the money ran out halfway through the road construction, then their money would have been wasted. So, the incentive was not significant, and everyone was waiting for the leader to take the lead, waiting for the award certificate of the top students, waiting for the maximization of their own interests. Seeing that the deadline set by the county for the road construction task was approaching, the village chief had no choice but to instruct the village accountant to use the village’s reserve funds first. He himself also took the lead in contributing money along with the village staff, and gave certain special benefits to the village’s influential people, ultimately successfully completing the road construction.

There are several key factors in this story:

  1. If people believe that getting rich requires building a road, it is crucial for them to be convinced.

  2. When the role of mobilization is not significant, and road construction is a task that must be completed, more measures related to mobilization will emerge until the road is successfully built.

  3. The village government and officials have contributed money and they will certainly not let their money go to waste. Even though they know that they are providing the cue for others to contribute, at least they have truly contributed money.

  4. Next is the arrival of construction workers and road construction equipment. When everyone sees the progress of road construction every day, they will be more willing to contribute money and effort because they have more confidence.

  5. It is reasonable to give appropriate rewards to those who take the lead in contributing money, as they play a role model in special times.

Expectations of the Dollar Index rising, Uncertainty about the RMB’s future.

I have answered similar questions many times before.

The long-standing expectation is that the Dollar Index will peak in Q4 of this year, and the RMB will begin to rebound, but do not have overly high expectations.

The reason is simple: the Dollar Index represents the US economy, while the RMB represents real estate.

The hawkish sentiment in the Federal Reserve’s September Economic Projections (SEP) this year led to high expectations of an interest rate hike by the Fed. However, in reality, economic data in the US has been deteriorating since Q2 of this year. Additionally, the US finally achieved positive interest rates in April. Generally, positive interest rates take about six months to have an impact. Therefore, it is expected that US economic data will officially worsen in Q4 of this year, combined with the overblown expectations from the Federal Reserve. In that case, the expectations will likely be revised downward.

The Dollar Index includes expectations of a strong US economy and continued interest rate hikes. Once these expectations start to decline, the dollar will depreciate. This is why, despite the Bank of Japan (BOJ) maintaining a 0 interest rate, the USD/JPY exchange rate has been falling in recent days. This is because the expectations of an interest rate hike need to decline first.

The economic downturn in the US will have a global impact, with two possibilities:

The first possibility is that the US experiences a hard landing similar to that of 2008, which will significantly drag down the global economy. This will cause a sharp decline in global trade, with the most affected countries being those with a high reliance on trade and weak economies, such as South Korea, China, Japan, and Europe. During this time, the country that stabilizes its exchange rate the most will suffer the greatest losses. It is highly likely that the US dollar will depreciate first, followed by other currencies engaging in competitive depreciation against the USD. However, there is a possibility that the RMB will stabilize. Nevertheless, the probability of a hard landing in the US is very low.

The second possibility is that the US experiences a mild recession similar to that of 2009. This would lead to a negative impact on global trade, but it would not significantly drag down the global economy. Regions with weaker economies will be somewhat affected, with South Korea, China, Japan, and Europe being among them. However, South Korea would likely be the least affected, followed by China. Japan and Europe would experience greater impact. This is because South Korea’s main export to the US is semiconductors, and the semiconductor industry is already at the bottom of its inventory cycle. If the US experiences a mild recession, it will not have much impact on the demand for semiconductors. On the other hand, China’s main export to the US is consumer goods, and the US has been experiencing deflation in consumer goods for over a quarter, indicating a long period of destocking near the bottom. If the situation worsens, there will be some impact, but it will not be significant. Japan and Europe have a large export of automobiles to the US, and although the US’s automobile industry has declined slightly this year, overall it is still good. However, in October, automobile prices began to enter deflation, indicating further deterioration in demand. Therefore, the impact on Europe and Japan is likely to be greater compared to China and South Korea.

However, I only anticipate a short-term depreciation of the dollar. I believe that in the long term, there is a high probability of the dollar entering an upward trend. The biggest variable lies in Japan. Below is a monthly chart of the Dollar Index’s trend.

As we can see, the monthly chart of the Dollar Index is still within an upward trend.

The Dollar Index consists of three major weights: the euro, the pound, and the yen. The economies of Europe and the UK are confirmed to be stagnant, and their core industries have started facing competition from China. The potential for future growth is likely to further decelerate. In the short term, the narrowing of interest rate differentials due to reduced expectations of a rate hike in the US may cause some pressure. However, in the long run, European long-term interest rates are definitely unable to be sustained at the same level as the US. It is probable that Europe will return to long-term deflation soon. From a fiscal perspective, Europe’s industries are becoming less competitive, yet they must maintain their current welfare programs. They can only achieve this through money printing. The fiscal deficit will become larger, which is also detrimental to exchange rate stability (the significant depreciation of the euro over the past decade in the face of such a weak economy is a result of money printing). The situation is similar for the pound.

The biggest uncertainty currently lies with the yen. I won’t go into detail about the yen here, but you can refer to my other response.

Unless Japan truly achieves a recovery and clear path forward, the long-term upward trend of the Dollar Index is unlikely to be broken. During that time, a mild recession in the US may trigger a significant recession in major economies around the world, leading to faster interest rate cuts in these countries. Currently, it is mainly based on the narrowing of the interest rate differentials due to lower expectations, but in the long run, interest rate differentials may further expand.

Therefore, I don’t believe that the dollar will depreciate significantly. I simply believe that the market has overinterpreted the recent rise in the Dollar Index since September due to the Federal Reserve’s statements. It is now just about finishing the decline in the post-September rise. If US data weakens further, the Dollar Index may decline slightly. First, fully price in the expectations of a rate cut in the US, and then look at the economic data in Europe, Japan, and the UK. At that time, expectations of interest rate adjustments in these three regions may also be revised downward, and the dollar may stabilize.

The biggest uncertainty still lies with Japan, and as for the RMB exchange rate, I have discussed it in several other responses. In the short term, it is influenced by the actions of the People’s Bank of China (PBOC) (China’s central bank, which has been stabilizing the exchange rate since August this year). In the long term, it is influenced by the real estate market. Since the RMB is not market-driven, in the short term, the PBOC has the final say. However, in the long term, it cannot go against economic laws. Ultimately, real estate will have the final say (real estate has now hit bottom and will undergo complete transformation, which will influence the exchange rate. If real estate collapses, the exchange rate may experience a significant decline).