Unit 4 Macro: China’s Foreign Currency Reserves | tutor2u Economics

Unit 4 Macro: China’s Foreign Currency Reserves

The rise in foreign currency reserves is largely the result of China’s enormous trade surpluses but also the consequence of intervention in currency markets by the Chinese central bank. To manage the value of the exchange rate it buys dollars and sells Yuan. China uses a large slice of their currency reserves to finance overseas investment including the role of Sovereign Wealth Funds to invest in developed and emerging countries including many in Africa. A rise in foreign currency reserves increases the money supply and has led to a surge in domestic lending including much money pumped into property developments.

A recent estimate valued Chinese foreign currency reserves at $3.2 trillion. In 2010, nearly two-thirds of China’s reserves were held in US dollar assets such as bonds, equities, money on deposit in US banks and property. But recently there are signs that Chinese investors have been diversifying away from the dollar.

What are some of the options for this mountain of foreign currency?

1. Currency intervention: There might come a time when the Yuan was under downward pressure and the Chinese central bank wanted to sell foreign currencies and buy domestic currency. But China has more than enough reserves to meet this contingency

2. Purchases of overseas government debt:  For a long time China has been a major buyer f new issues of US government debt. China is now the largest foreign creditor to the USA, and the latest figures shown that it increased its US Treasury holdings to $1.16 trillion in January 2012.  This gives China plenty of influence when it comes to US-Chinese trade disputes. Were China to reduce their purchases of US government bonds and move their investments into European debt or bonds issued in other parts of the world, this would reduce US bond prices and increase the cost of the US government borrowing. That said another effect of high Chinese ownership of US financial assets is that China is reluctant to allow a sharp depreciation of the US dollar and appreciation of the Yuan because that would hit the value of their US investments.

3. Sovereign Wealth Funds: China has a sovereign wealth fund known as the China Investment Corp (CIC) charged with making portfolio investment overseas. In recent times it lost money in high-profile investments in U.S. investment bank Morgan Stanley and private equity firm Blackstone Group but other investments have been more successful.

a. In 2011, Cheung Kong Infrastructure Holdings Ltd bought Northumbrian Water Group and the CIC acquired an 8.68% stake in Thames Water Utilities

b. Ahead of the 2012 Budget the UK Chancellor George Osborne welcomed discussions with Chinese investors to help fund British transport, energy and utility infrastructure projects.

c. In 2012, the CIC bought a 2 percent stake in France’s Total, the oil and gas giant

d. China has encouraged many businesses to make big capital investments in other emerging countries many on an African continent rich in natural resources.

4. Gold Purchases: China has chosen to use some of her foreign currency reserves to build up her stock of gold – a precious metal that has soared in price in recent years

5. Domestic investment and rural development and green technologies – the Chinese government has opted to use some of the accumulated currency reserves to help fund increased investment in rural areas of China in an attempt to support living standards and development in some of the poorest parts of this vast country. Chinese farm subsidies have grown, as a share of total farm incomes, subsidies in China have jumped from 6% in 1995 to 17% in 2010. The 12th Five Year Plan allocates more resources to green investments in traditional sectors, for example infrastructure spending and innovation to improve water and energy efficiency in farming in a bid to lift agricultural productivity and profits.



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