The value of the Chinese yuan is overvalued

Recently, the Chinese yuan exchange rate has rebounded, with the latest offshore yuan at 7.16, which means it takes approximately 7.16 yuan to exchange for 1 US dollar.

Since China's foreign exchange market has not been fully liberalized and the flow of capital accounts is subject to a certain degree of control, there has always been a view that the real exchange rate of the yuan against the US dollar has not been reflected. If foreign exchange controls are completely lifted, the exchange rate will plummet, and some even believe that 1 US dollar is equivalent to 21 yuan and have provided a derivation process.

Is this view tenable? Let's first look at how the 21:1 result was calculated.

A Chinese netizen based in the United States believes that the exchange rate will change after the yuan is fully freely circulated. When calculating the "real" exchange rate, he used the GDP and M2 data of China and the United States, with the specific process as follows.

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From January to September 2023, the GDP of the United States was 20.28 trillion US dollars, and the M2 balance as of the end of September this year was 20.76 trillion US dollars. This means that for every 1 US dollar of GDP, the corresponding M2 is 1.02 US dollars (20.76/20.28).

China's GDP for the first three quarters of this year was 91.3 trillion yuan, which is approximately 13.08 trillion US dollars. Multiplying by 1.02 US dollars gives the total amount of broad money M2 that should be issued according to the US standard, which is 13.34 trillion US dollars.

According to the financial statistical data report released by the central bank for the first three quarters of 2023, China's M2 balance at the end of September was 289.67 trillion yuan.

Therefore, 289.67 trillion yuan is equivalent to 13.34 trillion US dollars, resulting in a yuan-to-US dollar value of 21.7 (289.67/13.34), which means 1 US dollar can be exchanged for 21.7 yuan, and 21.7 is the real exchange rate of the yuan.

The above derivation is somewhat complex, and friends who did not understand can read it several times until they understand the internal logic. In short, this method determines the real proportion of US dollars to yuan by comparing the relationship between GDP and M2.

For those who have understood, do you think it is reasonable to calculate the real exchange rate of the yuan in this way? I can clearly tell everyone that it is purely nonsense. The person who put forward this view does not even understand the most basic logic and financial concepts. I will refute it from two aspects.First, there is a logical error in the calculation process.

In the step of calculating the so-called real exchange rate of the Chinese yuan, there is a step to convert China's GDP for the first three quarters, denominated in yuan, into US dollars. This is the aforementioned 91.3 trillion yuan GDP, which is roughly equivalent to 13.08 trillion US dollars, with an exchange rate of 6.98. This is the average exchange rate of the Chinese yuan against the US dollar from January to September this year.

Do you see the problem? It is clearly calculating the real exchange rate of the Chinese yuan, but the calculation process acknowledges and uses the current exchange rate. What kind of strange logic is this?

It is equivalent to proving that the conclusion is wrong and deriving the correct conclusion, but using the wrong conclusion as the calculation condition in the process of deriving the correct conclusion. It is a typical case of slapping oneself in the face.

Second, the composition of M2 between China and the United States is different.

Even if we ignore the logical errors, this calculation method cannot be established because it fails to correctly grasp the differences between China and the United States when calculating M2.

China's M2 covers almost all forms of money, including cash, demand deposits, credit card deposits, term deposits, trust deposits, etc.; the US M2 only includes a part of the money forms, such as term deposits above 100,000 US dollars, which are not included in the accounting range of M2 and belong to M3.

100,000 US dollars is not a large number. The United States has a large number of large enterprises, and the term deposits they have in banks are far greater than 100,000 US dollars, none of which are included in M2. Therefore, the statistical range of the United States' M2 is far smaller than that of China.

From the process of deriving the "real exchange rate," it can be found that the exchange rate of the Chinese yuan is inversely proportional to the M2 of the United States. If all term deposits above 100,000 US dollars and other money forms included in China's M2 are all included in the United States' M2, then the total amount of the United States' broad money will expand a lot, and the derived exchange rate of the Chinese yuan will be very different from 21.7.

The premise of comparison is the same conditions; otherwise, the correct conclusion cannot be drawn. It is like Xiao Ming and Xiao Zhang comparing who has better grades. Xiao Ming takes out the score of the Chinese language exam, and Xiao Zhang takes out the total score of Chinese and mathematics. It is obvious that this comparison method is problematic.Can the American M3 be used to derive the real exchange rate of the Chinese yuan? The answer is no, for three reasons.

Firstly, it still cannot resolve the logical errors present in the calculation process. Secondly, the forms of money included in the American M3 are still fewer than those in China's M2. Thirdly, it is impossible to find data on the American M3, as the Federal Reserve does not disclose it at all.

What is the real exchange rate of the Chinese yuan?

In my opinion, it is difficult to provide an accurate answer. To know the real exchange rate, it is necessary to fully liberalize foreign exchange controls. Without liberalization, it is impossible to observe the real situation, and any research or calculation is only at the theoretical level and cannot be verified through practice.

Some people use the GDP calculated based on the theory of purchasing power parity to infer the real exchange rate. Specifically, the World Bank's purchasing power parity method calculates China's GDP for 2022 as $30.3 trillion, while the National Bureau of Statistics announced the GDP for 2022 as 121.02 trillion yuan.

These two figures represent the same country's GDP data for the same year in different currency forms. The ratio between the two numbers is 3.99, and some people believe that 3.99 is the real exchange rate of the Chinese yuan.