Chinese authorities recently disclosed that China’s current foreign reserve has exceeded US$1 trillion in late October 2006. Not long ago, China had already replaced Japan as the country with the world’s largest foreign currency reserves. The news has once again shown a spotlight on China’s currency, with many of China’s trade partners believing that the yuan is seriously undervalued.
One trillion U.S. dollars is equivalent to one-fourth of the total market value of stocks listed on the Dow Jones Index—enough to buy Microsoft, Citibank, and Exxon Mobil combined, with the remaining enough for General Motors and Ford Motor Company. Although experts have suggested that the funds be appropriated to health, rural education, environmental protection, and other social security projects, Wu Xiaoling, the deputy governor of China’s Central Bank, recently made an explicit statement that the foreign currency reserve should not replenish the social security fund accounts. He reiterated that agencies that wished to use foreign currency reserves ought to pay an equivalent amount of Chinese currency in exchange.
While Chinese people may find it difficult to benefit from the huge reserves, they may have to suffer from the potential consequences. On September 12, 2006, the Bank for International Settlements (BIS) issued a warning to several emerging market economies, including China, that the huge reserves may present a dilemma, necessitating either raising their exchange rates or bearing the aggravated risk of inflation.
China’s foreign currency reserves come from exports and foreign investment. The Central Bank has been using the Chinese yuan to purchase U.S. dollars and other foreign currencies from enterprises and individuals. A recent article in the Wall Street Journal reported that, in order to maintain the unreasonably low Chinese RMB exchange rate, China’s Central Bank has to purchase about US$20 billion every month. In order to raise the money to buy dollars, the Central Bank either needs to issue more bonds or to put more cash into circulation. Infusing cash into the market will lead to inflation. On the other side, if the government distributes bonds, it will accumulate debt and the government will have to pay the dividend.
In the United States and China, many economic experts have already pointed out that the huge foreign currency reserve is not only a serious waste of resources but also a detriment to the interests of China. Chinese officials, who have thus far avoided facing the issue, have just begun to recognize this as a serious problem.
When Jiang Dingzi, vice chairman of the China Banking Regulatory Commission, was interviewed by the Study Times, the Communist Central Party School newspaper, he described China’s huge foreign currency reserves as one of the biggest economic problems. He added that China’s foreign exchange reserves are invested mostly in U.S. bonds. Although the liquidity of such assets is not a problem, the rate of return is not high. Because the value of the U.S. dollar has exhibited a long-term trend of decline, China is facing the risk that the U.S. bonds that China holds will depreciate.{mospagebreak}
With China’s rapid export growth, it is estimated that its foreign currency reserves will add another US$200 billion by early 2007. Mao Yushi, chief economist of Beijing Tianze Economic Research Center, a private economic research institute, said that, because Chinese officials are only now realizing that this is a serious problem now, it might already be too late. He added, If we had adjusted the exchange rate three years ago, when our foreign exchange reserves were only more than US$200 billion, we would not have today’s problems.
Economists worry that if China starts to sell U.S. dollars, it will cause the exchange rate of the dollar to plummet. As a result, the value of dollar-based Chinese investment will be greatly reduced. At the same time, the U.S. Central Bank will have to increase its interest rates. The U.S. economy will then stagnate or even enter a recession. The demand for imported products will drop dramatically, causing more damage to both China and the United States.
In today’s global economy, any move by either China or the United States will affect the entire world. Economists and politicians in both countries are painstakingly looking for ways out of this currency predicament.
Serene Lee is the hostess for NTDTV’s Economy Program.