China should not only concentrate on the level of exchange rate fluctuations for its exchange rate reform, but should also pay more attention to the flexibility of the exchange rate mechanism, in order to cope with shocks resulting from excessive liquidity.

Facing the excessive liquidity that results from excessive issuing of US dollars, to improve the ability in coping with the liquidity shock, China needs to introduce more a flexible exchange rate fluctuation to curb the speculative pressures and stabilize the expectations towards appreciation instead of only concentrating on the fluctuations of exchange rate level. In response to the speculative pressures, a more flexible exchange rate system is more preferable to a fixed exchange rate system and a system with lower volatility. When the floating space becomes smaller and the expectation of appreciation becomes stronger, the possibility for a unilateral increasing tendency of the exchange rate becomes higher. On the contrary, in a larger floating space, the exchange rate follows a two-way movement which will bring certain pressure and risks to speculative capital, thereby increasing the risks and cost of speculative funds and curbing the speculative operation under strong expectations.

In order to restore the balance of the economic structure, countries often reduce their foreign exchange reserves. Under such a situation, it is also necessary for the country to speed up its exchange rate reform. Exchange rates can be seen as the price between trade sectors and non-trade sectors. Under the less volatile exchange rate levels and various preferential policies, trade sectors consume more resources in the economic development process. Non-trade sectors, such as services, have been under oppression, which not only caused the imbalance of international payments and currency mismatch, but also led to the loss of residents' welfare. Exchange rate flexibility will further enhance the development of the service sector, thus enhancing domestic demand and optimizing the industrial structure.

In addition, efforts should be made to promote the reform of the foreign exchange management system. In terms of the objective effects of policies, China's current foreign exchange management system has aggravated the appreciation pressure, which is reflected in the pattern of emphasizing inflows rather than outflows. It is much easier for foreign capitals to enter China. But for outflows, complicated procedures are involved, which have artificially intensified the pressure on both foreign exchange supply and Yuan appreciation. Therefore, China needs to shift its current foreign exchange management system from one encouraging foreign investment inflows but limiting outflow of capital into a relatively neutral system. It needs to set up certain limits on capital inflows and meanwhile relatively relax the controls on outflow. For example, in terms of using foreign exchange, both enterprises and residents should have more decision-making power. Chinese mainland residents should be able to have more channels to use foreign exchange. By this means, China can allow the people to hold the foreign currencies.

In regards to external policies, China should be more proactive in strengthening international monetary cooperation and in urging US dollars to become a responsible currency together with the international community. Excessive liquidity is a specific manifestation of global economic imbalance. Within such an extensive framework, to clear up the excessive liquidity, China not only needs to rely on its internal restructuring, but also needs to rely on international monetary cooperation and adjustment mechanism by seeking cooperation.

In the current dollar-based international monetary system, the Asian countries should accelerate monetary cooperation and minimize the negative impact of excessive volatility of the US dollar exchange rate on the stable economic growth and capital flows of Asian countries. From now on, China can make policies for exchange rate cooperation in Asia, the region in which it has a relatively stronger influence, to eliminate the risks resulting from the current imbalance of global payments. In practical cooperation, China can introduce coordination mechanisms to adjust its intervention in the foreign exchange market and to stabilize the relationship between foreign currencies, so as to release the pressure on speculative capitals. Regarding global foreign exchange market, the United States, the world superpower, should not only blindly pursue its own economic objectives, but also should take responsibility for the solution of global economic imbalances. She should speed up reform through her own adjustment to alleviate the conflicts within the world economy.

The author Ba Shusong, deputy director and researcher of Finance Institute of State Council Development Research Center