China’s foreign exchange reserves had been close to 4 trillion US dollars, but it fell to around 3 trillion USD last year. The reason for such a substantial decline is that a great number of Chinese people have been exchanging their renminbi for foreign currencies. Who do they exchange with? The country of course. This explains the decline in China’s foreign currency reserves.

Why do the Chinese want to swap their renminbi for other currencies? It’s mainly because the renminbi has been on a depreciating trend. Though officials have claimed that the renminbi is the second strongest currency in the world, people would still want to hold the strongest currency instead, i.e. the US dollar.

For the past few months, the battle to defend the renminbi had been taking place. On one hand, China seeks to prevent the outflow of the renminbi. On top of that, it also wishes to prevent speculators and particularly financial crocodiles from short selling renminbi futures.

In order to prevent the outflow of the renminbi, the central government has adopted several measures. For instance, one would find himself blocked from buying insurance with credit card, or questioned thoroughly when investing overseas. The latest move is that the annual quota of settlement and purchase of foreign currencies (equivalent to USD 50, 000) will only be granted post-application, and the government may or may not approve.

Meanwhile, it is stated that the foreign currencies cannot be used to purchase property and stocks (though the restriction does not apply to the SH-HK and SZ-HK stock connect). The use of foreign currencies is under tight regulation even for those studying abroad. Illegal channels were also closed down.

In order to prevent “financial crocodiles” and big players from short selling the renminbi, a way is to deplete the supply of renminbi in Hong Kong, and force the renminbi outside China to appreciate drastically. This would increase the cost incurred by speculators who short-sell the currency.

Such a move proved to be effective temporarily. At one point, the exchange rate rose to less than 6.8 yuan per US dollar (from 7 yuan previously). However, the “financial crocodiles” were not easy to deal with, and the renminbi readjusted after a few days.

The battle to defend the renminbi goes on, though I don’t think it will last long.