China's Foreign Exchange Reserves Reach a Trillion Dollars

Brad Setser muses on the international financial situation:

RGE - A trillion dollars does tend to concentrate the mind: Brad Setser: Statistical agencies usually are not the authoritative source of information on a country’s reserve portfolio. Nor do they usually comment on exchange rate policy or the investment decisions of a country’s firms. But then again China may be different.

There is no doubt that China would love to see its companies invest more abroad, slowing its reserve growth. And China clearly has figured out that buying an asset that is likely to decline in value has a cost, even if the carry is positive. That said I am more confident that the RMB will rise in value v. both the euro and the dollar over time than I am that the euro will rise (further) in value v. the dollar....

A trillion dollars is just a number. But it is a big number. And a big milestone. By my count China already has over a trillion dollars in reserves and reserve-like assets. But I am counting the funds the PBoC shifted to the state banks. In a couple of months, though, China will formally announce that its reserves now top a trillion dollars. So it isn’t exactly a surprise that Chinese policy makers would be spending a bit of time thinking about how to use those funds.

The key fact for the global economy is not that China holds a trillion dollars in reserves. It is that those reserves are growing at a pace of around $20b a month/ $250b a year. This reserve increase has continued even as interest rate differentials have moved steadily in the dollar’s favor. China constantly struggles not just to invest its existing reserves productively, but to find new places to park its ever growing reserves.

Right now, there is no reason to think that China won’t have $1,500b in reserves in about two years time. Not unless Chinese policy makers show an ability to act far more decisively than they have so far....

Lex argues - echoing lots of academics - that China’s dollar reserves finance a net flow of FDI back into China.... I disagree, at least in part. China’s growing dollar reserves don’t finance US investment in China. They finance US imports of Chinese (and other) goods.... Chinese inflows support US domestic consumption, not US investment abroad.

The picture of central bank inflows financing FDI works - but for Europe. Europe attracted a ton of reserve inflows in 2005. Maybe $200b in total, and at least $50b from China. That financed a good chunk of Europe’s FDI....

Europe is now to the world what the US was during the heyday of the original Bretton Woods system: growing euro reserves finance Europe’s growing investment abroad. The US, by contrast, needs those reserve inflows to finance a big current deficit. There is a difference.

Comments

[milly]

Brad--you've got the headline wrong here.

I read "Billion Dollars" and thought: is that all? Big whoop!

THen I read the real post.

[Francis]

It would appear that the issue of Chinese regional banks being technically insolvent due to uncollectable debt is now moot. They have been recapitalized with US Treasuries.

[hardy]

wow--who knew that comments-spam could have a sense of humor?

Those Chinese--such characters!

[Alan]

So just where do you park a trillion plus dollar is you happend to pack that much away? Passbook savings at Wells Fargo? The interest alone should fund their military.

Seriously, what is stopping PRC from just buying major if not controlling interest in every international corporation? If nothing is stopping them, why don't they?

[Nathan Morton]

This is absolutely the case. I read a couple of articles in the FT on Wed. and the concept was approached therein. Chinese dollar reserve holdings are approaching one trillion. In order to avoid a B.O.P. crisis, the Chinese have two general options. They can either:

1. Divest themselves of new T-Bill offerings (or invest at a slower rate) to curtail money supply growth and transition off the current peg, which will cause the Yuan to appreciate against the dollar.

2. Keep on buying every new T-Bill offerred up by Bernanke and the gang, continuing the course unabated.

If 1., the dollar will slowly depreciate against the Yuan, in which case both currencies fall concomitantly against the money market. A fundamental disequilibrium will continue to exist between market rates and the dollar/Renminbi peg, but it won't be exacerbated as much.

If 2., things will continue as they are until we see that long-term bond holders lose money in relation to short-term debt securities (inverted yield curve), which suggests Chinese neomercantilists have reached the apex of decreasing marginal utility and thus begin to experience negative [real] rates of return on credit sales.