So far this year, the most remarkable change in international financial market is that U.S. dollar shows a clear trend to become stronger, but Japanese Yen exchange rate keeps declining driven by Abenomics, which refers to the economic policies advocated by Shinzō Abe, the current Prime Minister of Japan.

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Replying to the rise of U.S. dollar, China begins to carry out a contractionary monetary policy. The contractionary policy expands the money supply more slowly than usual or even shrinks it. China's contractionary policy is intended to slow inflation in order to avoid the resulting distortions and deterioration of asset values.

A policy is referred to as contractionary if it reduces the size of the money supply or increases it only slowly, or if it raises the interest rate. Furthermore, monetary policies are described as follows: accommodative, if the interest rate set by the central monetary authority is intended to create economic growth; neutral, if it is intended neither to create growth nor combat inflation; or tight if intended to reduce inflation.

The depreciation of Japanese Yen will block the industry upgrades of China. Though the depreciation will promote economic growth in Japan, it will cause China to put into effect the contractionary monetary policy. The weakening currency of Japan could affect China's economy. A weaker yen will put appreciation pressure on other currencies and lead to trade frictions. According to related research, a 20-percent depreciation of the Japanese yen against the Chinese RMB could lead to a 2.5 percentage point drop in China's exports. Moreover, China's auto and electronics exports to third parties will be challenged, as lower prices offered by Japanese rivals will be more competitive.

In addition, Japan instituted aggressive monetary quantitative easing policies will inject more liquidity into the global economy and increase the volatility of the world's capital market. And these policies may lead to global price hikes in energy and bulk commodities, as well as impose inflationary pressure on China.

As the stronger U.S. Dollar and weaker Japanese Yen squeeze Chinese economy, we should accelerate the reform of RMB exchange rate formation mechanism. In this way, China will correct the exchange rate of overvalued RMB with the help of economic market's self-correcting mechanism.