What Is Weak Currency?

"Currency liquidity" refers to M1 / M2, which reflects the amount of money put on the market.

Currency liquidity

currency

Currency liquidity ratio M1 /

Current currency liquidity is mainly manifested in the following areas:

Excess money supply

In response

A Theoretical Study of the Impact of Currency Liquidity on Asset Prices

The changing trend of currency liquidity reflects the loose or tightening monetary environment. The changing characteristics of asset prices in different monetary policy environments are issues of concern to every institutional investor and have important practical significance.

Economic Implications of Currency Liquidity

Monetary Liquidity reflects a basic condition of the money supply. At the macroeconomic level, we often put liquidity

Currency liquidity

Sex is directly understood as the total amount of money and credit of different statistical calibers. The deposits of residents and businesses in commercial banks, and even bank acceptance bills, short-term government bonds, policy financial bonds, money market funds, and other high-liquidity assets can be included in different macro-liquidity categories according to the needs of analysis. The indicators for measuring the total amount of money include M0, M1, M2, M3, etc. M0 refers to cash in circulation. "Currency in the narrow sense"-M1 is usually composed of cash held by the public and the demand deposits of commercial banks that circulate outside the banking system. "Money in a Broad Sense"-M2 adds time deposits and savings deposits from commercial banks to M1. M3 added the liabilities of non-bank financial intermediaries on the basis of M2. Broad money covers various forms of currency held by different financial institutions, and is well-suited to the needs of the modern economy. It has become an important indicator of concern of monetary authorities in developed countries. . China's central bank regularly publishes the statistics of the narrow money supply M0 and M1, and the broad supply M3.

The Quantity Theory of Money pointed out the correlation between the money supply and economic activity and the level of prices, which can be specifically expressed by the Fisher Equation: MV = PT. Among them, M refers to the money supply; V refers to the velocity of money circulation; P refers to the average price level; T refers to the transaction volume of goods and services. The theory assumes that the currency circulation speed (V) and transaction volume (T) will not change in the short term. In this way, an increase in the money supply (M) will cause an increase in the price level (P), leading to inflation. The specific form of liquidity is deeply affected by changes in financial institutions and their actual activities. Its complexity and variability may make the relationship between money and the economy as understood by traditional quantity theory of the currency unstable.

In recent years, the capital market and its derivatives market have developed rapidly. Many economists have proposed that currency is used to meet the needs of all economic activities, including not only commodities in circulation, but also assets, so the Fisher equation should be revised. MV = PT + S, where S represents the demand for money in the capital market. Another criticism of the traditional theory of quantity of money is that many scholars believe that the velocity of currency (V) changes according to the environment of economic and commercial activities and should not be assumed to remain completely unchanged. These suggestions for improving the quantity theory of money reflect the development and change of economic activities. The basic laws revealed by the theory of quantity of money are worthy of our study and further exploration.

The changing trend of currency liquidity reflects a loose or tight monetary environment. The economic definition of excess liquidity is: the positive deviation between the actual amount of money in circulation and the amount of money needed in an economic equilibrium. Excess liquidity can be understood as the money supply exceeds the need to maintain long-term price stability. According to the definition of excess liquidity, when measuring excess liquidity, first estimate the total amount of theoretical currency in the state of economic equilibrium, and then calculate the difference from the actual total amount of money to obtain the specific value of the excess or shortage. In practical applications, it is difficult to determine what level of money supply is most reasonable, and there are many arguments in economic theory. Therefore, the excess of liquidity we observe in practice is not an absolute level of excess, but a relative excess, that is, the development trend of loose or tightened currency liquidity.

We can use the ratio of currency growth rate to nominal GDP growth rate to measure the trend of currency liquidity. Assume that the velocity of money circulation is unchanged. If the growth rate of money supply and circulation speed exceeds the growth rate of real objects and prices, liquidity will have a loose tendency to change, otherwise it will have a contraction. In addition, we can also measure liquidity using the true interest rate level that represents the price of money flowing. When interest rates fall, there is a loose tendency for liquidity to change, and vice versa.

Theoretical explanation of currency liquidity affecting asset prices

Maintaining a stable price level has always been the focus of monetary policy authorities and one of the ultimate goals of monetary policy. The level of asset prices that attracted the attention of monetary policy authorities can be traced back to the US economic bubble of the 1920s, which was further reflected in the high-tech stock bubble of the 1990s. In the above two periods (1923-1929 and 1994-2000), the stock market index maintained an average annual growth of more than 20% over the two six years, and both were accompanied by low and stable inflation levels. And very high real GDP growth rates. At the same time, currency circulation and loans also grew rapidly in these two phases. These facts show that the impact of asset prices on the economy is huge, and it also reveals that the money supply is highly correlated with asset price levels.

In recent years, major countries in the world have successfully controlled the price level of consumer goods at a relatively stable level. Federal Reserve Chairman Bernanke has pointed out that the focus of monetary policy in Western countries has shifted from inflation to asset prices. Former Federal Reserve Deputy Chairman Ferguson also pointed out why the monetary authorities are concerned about asset prices: because asset prices are an important part of the transmission mechanism of monetary policy, extreme changes in asset prices will cause monetary policy to have no effective impact on economic activities; in addition, Asset prices contain important information about monetary policy and have an information disclosure role. The central bank needs to ensure that the information it reveals is consistent with monetary policy. The increased attention of monetary policy authorities to asset prices reflects the important role of asset prices in the transmission mechanism of monetary policy, and also requires institutional investors to better understand the mechanism of the role of money supply on asset prices and grasp the market. Towards.

The impact of currency liquidity on asset prices (including bonds, stocks, and real estate prices) can be theoretically explained in the following aspects:

First, the transmission mechanism of monetary policy tells us: an increase in liquidity will cause a decline in short-term interest rates; a decline in short-term interest rates will cause a decline in long-term nominal interest rates; a decline in long-term interest rates will cause stock prices to rise. The current practice of the Federal Reserve's current monetary policy is to set a target interest rate based on the state of economic development, and then adjust the state of the money supply (the supply of the Federal Reserve) until the Federal Reserve rate reaches the target interest rate level. Suppose the Fed wants to reduce interest rates. The Fed chooses open market operations to buy bonds in the interbank market. This causes the price of bonds to rise, the rate of return to fall, and interest rates to fall. The Federal Reserve s actions have increased the federal reserve that commercial banks can hold, which in turn has increased the amount of credit that commercial banks can issue, and ultimately increased the total amount of money in circulation in the economy.

The interest rate level measures the price of money flows. Long-term interest rates are closely linked with short-term interest rates, and the return on bond assets (such as government bonds) is an important criterion for measuring the level of long-term interest rates. Thus, the decline in bond interest rates when liquidity increases has a theoretical basis. The fall in long-term interest rates reduces the rate of return on debt assets. When the level of equity asset risk premium remains unchanged, it also reduces the investor's required rate of return on equity assets. The reduction in the required return on stock assets makes the current return on stock assets exceed people's expectations. People put money into stocks to raise the stock price and reduce the stock return rate until it matches the required return rate. The price of the stock depends on the stock. Supply and demand. When calculating the intrinsic value of the stock (such as the DDM model, the intrinsic value of the stock = future earnings / required rate of return), the future earnings or dividends of the company represented by the stock, as well as the interest rate and required rate of return, all play a decisive role. (Baks and Kramer, 1999).

Declining bond rates and rising stock prices can also be explained by substitution effects. Funds are profit-oriented. When the return on bond assets declines, the funds will enter the stock market to obtain high returns until the entry of funds causes the stock price to rise and the return rate to decrease, reaching the level of risk premium that the stock assets should have. In addition, the loose monetary environment after increased liquidity has raised expectations for economic output and raised expectations for the company's profitability. The reduction in required returns and the increase in corporate earnings expectations will increase the intrinsic value of the stock.

Second, the theory of quantity of money shows that when the liquidity of money is higher than the needs of the economy, it will raise the price level. When the price index remains stable, asset prices rise. This explanation is based on the wealth effect brought about by the excess of money. The wealth measured by currency in the possession of residents has increased; the wealth effect will be used to purchase goods; if the price of consumer goods remains stable, then wealth will flow to assets and asset price levels will rise. This explanation is also applicable to the relationship represented by modern monetary quantity theory (MV = PT + S, where S represents the need for money by assets). Money needs to meet all the needs of transactions, including not only consumer goods but also assets. Judging from the two largest stock market bubbles in the history of the United States (1923-1929, 1993-2000), there are phenomena of stable prices and sharp rises in asset prices.

Many scholars have conducted a lot of empirical analysis on the mechanism of the US historical situation on the influence of currency liquidity on asset prices, including:

Jensen and Johnson (1995) used the change in the direction of interest rate adjustment as a measure of the Federal Reserve's tightening monetary policy or loose monetary policy. They analyzed the relationship between US stock returns and the monetary environment from 1962 to 1991 and found that the stock market is closely related to the monetary environment. When the monetary environment is loose, the stock returns are higher than when the monetary environment is tightening. Patelis (1997) also used different monetary policy variables to reach the conclusion that monetary policy has an effect on the stock market. Mashall (1992) analyzed the quarterly data from 1959 to 1990 in the United States. He compared the growth rate of M1 with the ratio of consumption to GNP to measure currency growth, and found that the actual stock return was weakly positively correlated with currency growth. Conver, Jensen and Johnson (1999) found that the correlation between stock returns in some countries and US monetary policy is very significant, and some are even stronger than the correlation with domestic monetary environment. Baks and Kramer (1999) studied the mechanism of the role of currency liquidity in international markets. They found that the increase in currency liquidity in G-7 countries was in line with the decline in real interest rates and the rise in real stock prices in G-7 countries. Bordo and Wheelock (2004) studied the major financial bubbles and financial crises in the history of the United States and found that the formation of financial bubbles is generally accompanied by the excessive growth of currency issuance and bank loans.

Ferguson (2005) used the M3 growth rate to represent changes in the money supply, and found that the increase in currency liquidity is limited to the stock price, but to a very high degree to the real estate price. He believes that statistical non-significance does not deny the effect of monetary policy on asset prices. The reason for this result may be that the stock price fluctuates too frequently, and ordinary correlation analysis cannot find the rules.

Summarizing the previous analysis, the theory that currency liquidity has an effect on the price of stock assets has theoretically reached consensus: loose liquidity plays an important role in promoting the stock market. On the one hand, the theoretical community has highly affirmed the correlation between the two, and on the other hand is seeking a breakthrough in statistical analysis methods.

Correlation Analysis of China's Currency Liquidity and Stock Price

(I) Main characteristics of China's currency liquidity

Currency liquidity

At present, China has basically established a framework that uses a stable monetary value as the ultimate goal and the money supply as an intermediate goal, and uses various monetary policy tools to regulate the base currency (operational goal). The current monetary policy of the People's Bank of China is a stable monetary policy, and the management of monetary liquidity is mainly to adjust the management of the money supply (PBC, 2005). According to China's current foreign exchange system, companies want to sell foreign exchange balances to designated foreign exchange banks. This is the so-called forced foreign exchange settlement and sales system. Foreign exchange banks must sell foreign currency funds in excess of the designated foreign exchange position to the central bank. In this way, the central bank of China has become the de facto receiver of the foreign exchange market, and the initiative of central bank liquidity management is relatively weak. The central bank s massive increase in currency investment to hedge huge foreign exchange accounts is the direct cause of China s abundant liquidity. In this way, loose currency liquidity has become an important feature of China s monetary policy in recent years.

First, the money supply accounted for a large proportion and the growth rate was fast. Compared with other countries, the ratio of China's money supply M2 to GDP is very high. From the perspective of the development trend of the ratio of M2 to GDP, it shows a clear upward trend. This reflects the loose liquidity of China's currency from one aspect.

Second, the currency growth rate is compared with GDP growth rate. Figure 3 shows the comparison of M2 growth rate with GDP growth rate in the past 15 years (1991-2005). We can find that the growth rate of China's broad money supply exceeds GDP growth in most years.

Third, market interest rates are on a downward trend. China's interest rate formation mechanism is still imperfect, and no recognized benchmark interest rate for the money market has been formed. Among the many short-term interest rates, the interbank rate is most similar to the Federal Reserve's Federal Reserve rate. The interbank rate is a market-based interest rate and has the necessary conditions to become the benchmark interest rate. In the absence of a better option, we use the 7-day interbank rate as the standard for measuring the price of liquidity. The year-on-year downward trend in interbank interest rates reflects the phenomenon of loose currency liquidity in China. The yield to maturity of government bonds also shows a downward trend, which reflects the changes in long-term interest rates to a certain extent. However, we find that the trend of the interbank rate is not consistent with the change between M2 growth rate and GDP growth rate. This is due to the differences in the content of the two indicators. The main component of M2 is currency in circulation and bank deposits, which does not reflect the currency held by non-bank financial institutions, and reflects the currency status of circulation and savings; while the money market interest rate reflects the currency status of all financial institutions, It reflects the situation of money supply and demand in investment behavior. The author believes that currency liquidity reflected by interest rates has a broader meaning.

(II) A statistical analysis of the correlation between China's capital market and currency liquidity?

The relationship between currency liquidity and asset prices can be summarized as: the increase in liquidity has a wealth effect, and the wealth measured by the residents has increased, increasing the purchase of goods and assets; the increase in liquidity has a substitution effect, causing short-term interest rates and long-term The decline in interest rates has increased the intrinsic value of stock investments. Liquidity is profit-oriented. When currency liquidity increases to increase bond prices and reduce bond returns, investors will enter the stock market or real estate market to seek higher returns.

In the statistical verification analysis, we selected the Shanghai Stock Exchange Composite Index as the index of stock market returns, the housing sales price index as the real estate return index, and the interbank treasury bond repurchase rate as the fixed income return index. The difference between the growth rate of the broad money M2 and the real GDP growth rate is used to measure the trend of currency liquidity. Taking the first quarter of 1997 to the third quarter of 2006 as the time period, we used the vector autoregression model (VECTOR AUTOREGRESSION) to analyze the above indicators. We found from the results that the Akaike AIC and Schwarz SC indicators reflected The correlation between currency liquidity and stock index is weak. Granger Causality Test is an analysis method that analyzes whether there is a sequential relationship between index relationships. When we analyzed using Granger's causality test, we found that the currency liquidity index occurred before the national debt index, and the currency liquidity index was statistically significant in explaining the government bond repurchase rate. Currency liquidity is statistically significant for explaining changes in house prices; currency liquidity is statistically less significant for explaining stock returns.

(3) Analysis of statistical results and main conclusions

The theoretical community generally believes that increased liquidity will raise prices. First, the increase in liquidity has a wealth effect. The wealth of residents measured in money has increased. If the supply of consumer goods is met, excess money will flow into the real economy and be used to purchase assets, which will raise the prices of real estate and stock assets. Without the rise in the price level, the asset price level May increase significantly. Secondly, the increase in liquidity has a substitution effect, causing short-term interest rates and long-term interest rates to fall, thereby reducing people's required return on stock assets and increasing the intrinsic value of stock investments. Funds are profit-by-profit. When currency liquidity increases to increase bond prices and reduce bond returns, excess funds prompt investors to seek investment paths with higher returns. We found in the analysis of historical data: First, China has ample liquidity, and the ratio of broad money to GDP is high compared with other countries. Although the central bank has taken various measures to tighten liquidity, the interbank borrowing rate in recent years Continued decline, the performance of ample liquidity in short-term interest rates. Second, the results of statistical analysis show that the impact of currency liquidity on raising the price of bond assets is significant. The 7-year maturity yield on behalf of long-term interest rates is consistent with the trend of short-term interest rates. Third, the statistical results reflect that liquidity has a limited effect on stock prices.

Summarizing related theories and empirical analysis in China, we believe that liquidity is the decisive factor in determining bond assets. Currency liquidity is a necessary condition for stock asset prices and rise. The statistical results are not significant because the stock price fluctuates frequently, and the factors affecting the changes in China's stocks are many and complex. More sophisticated statistical methods are needed for further research. Since the end of 2005, with the completion of reforms such as the split share structure, breakthroughs have been made in the construction of the stock market system, investor confidence has increased, and a large amount of funds brought by abundant liquidity have sought investment returns other than bonds. The stock market provides great support. From the perspective of the increase in the number of shareholders opening accounts, a large amount of funds entering the stock market is undoubtedly the primary supporting force for the stock market's rise. Comprehensive analysis, we think that in the analysis of stock assets, we need to consider the role of other factors. It should be noted that this article studies the general law of liquidity on asset prices. We believe that bond and stock asset prices in the short term depend on the matching of supply and demand. When making specific investment opportunities and product choices, we should consider the possibility of Many factors affecting the relationship between supply and demand. ?

We believe that institutional investors should consider currency liquidity factors when making asset allocation decisions. At this stage, factors such as international trade conditions, capital flows, and changes in monetary policy are important reasons affecting China's currency liquidity situation, which deserves investors' attention. In addition, with the further development of China's capital market, the role of asset prices in the economy will be further enhanced. Therefore, the central bank should consider asset price factors when making monetary policy decisions.

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