December 15, 2004

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The Chinese value of a dollar

In a piece titled Five hows and whys about China's foreign exchange the People's Daily lays out China's official position on forex issues. Bear in mind that the very last people to admit to any change in policy will be the Chinese Government itself. That said, some interesting points...

Q: According to the report from the web there are several hundreds of billions or even trillion of US dollars of international hot money which are now gambling on the revaluation of the People's Currency, is it true or not?

A:...So far the capital count in China has not yet fully opened to the outside and so it's very hard for the speculative capital to get in boldly and openly on an extensive scale...we've discovered that there are some false reports in the import and export prices under the present trading items, a forgery of advanced collection of goods payment yet actual postponement in payment while the direct investment items are not true to the fact with abnormal phenomena to appear in excessive loans and the manipulation of the real estate market, etc. This is quite likely aiming at arbitrage by way of speculation...we'll continue to make a clamp down on [these rorts] later by monitoring and controlling closely on the capital flows.

In other words the rorting has been domestic in nature, and China sees little impact from hedge funds and speculative money. Combined with a financial system full of bad debts, they aren't in a hurry to fully liberalise the capital account. Now for the juicy bits:
Q: According to the foreign media China has reduced and sold out a lot of USD capitals in the management of foreign exchange reserve? I would like to ask whether the case is true or not?

A:...China has always been adhering to the "security, circulation and value-adding" principle in the management and operation of the foreign exchanges...China carries out the handling for the foreign exchange reserve structure in accordance with the long-term and strategic structure standard without taking the advantage for profiteering from a short-term exchange fluctuation...China has already taken into full consideration the needs for overseas payment when China was deciding its currency structural standard of foreign exchange reserve. And so there is no such thing as to change the US dollars into other currencies due to the shortage of the currency in the actual payment, thus causing the probability of the loss in the exchange trading.

Q: There is still another kind of view in society, holding that the foreign exchange reserve faces a big risk and a very high cost. Is it the case that the loss outweighs the gain when China holds in its hand a lot of foreign exchange reserves?

A: A reasonable scope and scale of foreign exchange reserve for a country is a very complicated question. The foreign exchange reserve held by the central bank (PBOC) is fundamentally for maintaining a macro-economic stability...good for coping with the unexpected events, preventing from the happening of systematic financial risk and maintaining the security of the national economy...It is sure that certain amount of cost is necessary for the keeping of foreign reserves. Any central bank of any country will have certain amount of cost in currency operations. However, should the overall macro-economy or financial system be mired into a vibration or even crisis the whole country and society will have to pay a hell lot of cost for it.

Brad deLong has had a look at the "cost" of supporting the renminbi. What's clear from the official statement is that China sees its reserves as a macro-economic insurance policy. They aren't too concerned if the US dollar loses value, because most of its trade is denominated in US dollars. Effectiively the Chinese economy is a dollarised one. So long as the majority of its trade continues to be denominated in US dollars (and note that's not the same thing as only trading with the US) then its forex reserves are no problem. If China is prepared to continue investing in Treasuries it might even allow other central banks to diversify away and allow a relatively painless drop in both the US dollar and US Treasuries.

China is not looking at its foreign reserves as an investment. It is looking at them as insurance.

posted by Simon on 12.15.04 at 09:56 AM in the


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What is "rorting"? Is it possible to use that word in a non-economic context?

posted by: Matt Waters on 12.15.04 at 01:55 PM [permalink]

Rorting is ripping off, gaming the system.

posted by: Simon on 12.15.04 at 02:01 PM [permalink]

Got it.

posted by: Matt Waters on 12.16.04 at 12:26 PM [permalink]

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