Description of the Economic Situation
This paper provides a real-world analysis of China’s Forex reserve fall due to government intervention of the Yuan. On September 7, 2015, the Wall Street Journal ran a front-page article entitled “China’s Forex Reserves Fall by Record $93.9 Billion on Yuan Intervention.” According to Lingling Wei and Anjani Trivedi (n.d.) the writers of article, China’s foreign exchange reserves plunged to the record lowest amount in August 2015 due to the government’s activities of intervening in the Yuan. The economic event actually underscored the intervention measures by the country’s move to prop up the Yuan. For the last few months, the People’s Bank of China has been straining to control the country’s forex reserves through various intervention measures.
It was a drastic fall in the amount of forex reserves as recorded by the country’s central bank; they confirmed that in August 2015 the forex reserves fell by $93.9 billion, the highest ever recorded drop since 2012. The decline in forex reserves eventually accelerated serious of economic events in the country leading to a deepening trend in the exchange rate forcing the country to consider slowing down on her intervention measures. In addition, the deep fall in foreign currency reserves has led to increasing capital outflow in china thus directly affecting other sectors of the economy. The following two graphs illustrates the sharp fall in China’s forex reserves during the month of august 2015.
Graph 1: Forex reserves as a percentage of Chinese GDP
Graph 2: Number of imports facilitated by forex reserves in China
Analysis of the Economic Situation
The economic event in China can be explained using supply and demand model (AA-DD model). This economic model can be used to model and explain the declining foreign currency reserves in China. This model uses diagrams to describe the relationship between supply and demand as well as the effects of intervention measures in the foreign currency market. Using the AA-DD model allows us to analyze and understand the forex market situation in china as well as the effect of the central bank’s intervention measures.
Before the onset of the forex reserve fall in August, the people’s bank of China, has been actively selling its US dollar reserves as an intervention measure to prevent Yuan from sliding. This led caused the supply of US dollars to decrease drastically thus the resultant high demand. The resulting increased demand for dollars caused the reserves to fall drastically. Even though the Chinese central bank managed to keep the Yuan from sliding further, the country experienced a drastic fall in its currency reserves. This phenomenon can be illustrated using the AA-DD model below.
The graph above illustrates that increase in the sale of US dollar reserves by the central bank causes a shift in the US dollar demand to the left from D to D’. The shift in market demand causes a decrease in the amount of dollar reserves in china from Y1 to Y3. This resulted in a drastic fall in the amount of US dollar reserves in the country as experienced during the month of August 2015.An increased sale of the dollar reserves causes a shift to the left along the demand curve. Therefore, the amounts of dollar reserves will continue to declines along as the central bank continue with its intervention policy for the Chinese Yuan.
Trivedi, Anjani, and Lingling Wei. “China’s Forex Reserves Fall by Record $93.9 Billion on Yuan Intervention.” WSJ. Wall Street Journal. Web. 3