http://online.wsj.com/public/article/SB116104977336494710-zBVM_zV0Jesbbj4X8Gky0Axd468_20061023.html?mod=regionallinks
BEIJING -- Sometime in the next few days, China's holdings of foreign
currencies and securities will top $1 trillion -- a sum greater than the annual
economic output of all but nine countries. The rapid growth in these so-called
foreign-exchange reserves has made Beijing a colossus in the financial world,
cushioned against shocks at home, but potentially able to trigger them abroad.
How China manages its growing pool of wealth has major repercussions for the
global economy. Beijing's reserves totaled $987.9 billion as of Sept. 30 and are
growing by roughly $20 billion a month. That total compares with the about $1.2
trillion in assets under management at U.S. mutual-fund giant Fidelity
Investments.
As the pot grows, the secretive and sophisticated portfolio managers at
China's central bank are trying gradually to boost their country's returns on
its foreign-exchange holdings, at least in part by making somewhat riskier but
higher-yielding investments. Last spring, an unsuccessful effort to divine their
intentions sparked a steep run-up in the price of gold.
For the U.S., how China deploys its reserves is a question of some
consequence. Most of China's currency reserves are invested in
U.S.-dollar-denominated debt, such as U.S. Treasurys, which are considered the
world's safest investment. That has kept demand for U.S. Treasury notes high --
and interest rates low. A change in that pattern could affect how much Americans
pay for mortgage loans and other borrowings.
Some in Washington and in world markets fear that China might one day dump
its holdings of dollar-based assets, setting off a tidal wave of sales that
might swamp the U.S. economy. Despite such fears, there's no sign that China is
making a major move out of dollars and into euros or other foreign currencies,
even though Chinese economists have occasionally warned that the weak dollar
holds down the value of China's holdings.
China discloses almost nothing about its reserves, beyond their awesome size.
Roughly 70% of the Chinese reserves are believed to be in U.S. dollar assets,
20% in euros and 10% in other currencies, including the Japanese yen and Korean
won, according to Brad Setser, an economist at Roubini Global Economics.
China's enormous nest egg adds to its ability to project its influence around
the world. The prospect that the Chinese central bank's State Administration of
Foreign Exchange could spread its investments more widely hangs over global
markets, says Richard Yetsenga, Hong Kong-based currency strategist at HSBC.
"People think about diversification all the time," he says. The only other
investors that rival SAFE in size, Mr. Yetsenga says, are Russia and the
oil-producing countries of the Middle East.
As China's reserves balloon, markets and many U.S. officials believe it to be
buying less U.S. Treasury debt, which is explicitly guaranteed by the U.S.
government, and more debt issued by U.S. mortgage lenders Fannie Mae and Freddie
Mac, which carries an implicit government guarantee.
China's shopping list also is said to include somewhat riskier but
higher-yielding mortgage-backed securities and U.S. corporate bonds.
Financial-market traders and analysts also believe China has begun to dabble in
even riskier dollar-denominated emerging-market debt, operating through private
money managers around the world.
The country's massive foreign-exchange reserves are a direct result of
China's effort to manage the exchange rate of its currency. To prevent the value
of the yuan from strengthening too rapidly and hurting China's exports, the
country's central bank buys dollars from foreign investors and China's own
exporters, issuing yuan in exchange.
The abundance of yuan created in this way holds down the Chinese currency's
value. But the resulting mountain of foreign-exchange holdings opens China to
accusations from the U.S. and others that it manipulates its exchange rate to
make its products unfairly cheap on world markets.
Chinese central bankers also worry that the plentiful supply of yuan is
overheating China's economy and causing unwelcome inflation. Asked by reporters
last month about the size of the reserves, central-bank governor Zhou Xiaochuan
said: "We think we've got enough."
China's reserves already far exceed what the country needs to protect its
economy from global financial shocks: $1 trillion is roughly 1.25 to 1.5 times
China's total import bill last year and is equivalent to roughly 45% of the
year's economic output. The total could pay off China's total short-term foreign
debt six times over. It dwarfs the world's single biggest mutual fund, American
Funds' Growth Fund of America, with $147 billion in assets, and makes Harvard
University's $30 billion endowment look like pocket change.
The latest data from the U.S. Treasury Department show that, as of June 2005,
China's public and private sectors held a total of at least $527.3 billion in
U.S. securities, including about $450 billion of long-term U.S. Treasury or
agency debt. The composition of its dollar assets suggests that China is a more
sophisticated portfolio manager than Japan, which is believed to keep a larger
fraction of its $881 billion in reserves in short-term U.S. securities. But the
Treasury's figures may underestimate China's holdings because the U.S.
government can't always identify the ultimate owner of its debt.
Indeed, the Chinese central bank's State Administration of Foreign Exchange
leaves few tracks as it buys and sells assets through dealers all over the
world, as well as through the largely state-owned Bank of Communications in
Shanghai. The sums are so large that traders and analysts from Hong Kong to
London prize even the slimmest details.
The flimsiest reports from China on the management of its reserves can cause
gyrations in global markets. In May, for instance, China Gold News, a leading
industry publication in China, carried comments from a Chinese economist who
said China should raise its holding of gold to 2,500 metric tons from 600 tons.
The economist, Liu Shanen, doesn't speak for SAFE: he is a part-time
economist at the Beijing Gold Economy Development Research Center, a government
organization closely affiliated with state-owned mining groups. Nevertheless,
the report helped push gold prices to a 25-year high.
By spending a large chunk of its national savings to buy U.S. debt, China is
helping keep mortgage rates in the U.S. low at a time when the money could be
put to use in its own huge, developing economy. The Chinese health system is
collapsing; schools are starved of funds; social welfare systems are in dire
need of cash.
In the brewing debate about how the reserves could be better spent, Premier
Wen Jiabao has suggested that some of the funds could be set aside to buy high
technology to transform Chinese businesses. Vice President Zeng Qinghong
advocates using the money to buy raw materials that China lacks. Meanwhile,
former U.S. Treasury Secretary Lawrence Summers has been barnstorming the globe
telling countries like China they are squandering resources by parking billions
in low-yielding U.S. debt securities.
Some Chinese economists advise caution. Using foreign-exchange reserves to
invest in oil and other commodities is "far too risky," warns Yi Xianrong, a
researcher at the Chinese Academy of Social Sciences, a leading think tank. He
advises buying fewer dollars and larger quantities of other currencies.
Just this month, comments by an adviser to the central bank that it was risky
for China to hold so many dollars sent the dollar slipping from multimonth highs
against major currencies. But Fan Gang, a member of the central bank's monetary
policy committee, speaking at a financial forum, was quoted by Reuters news
service as saying that China had few alternatives to dollar investments.
U.S. officials currently worry less about China dumping its dollars than they
do about the prospect that some developing country, unhappy with conditions on
International Monetary Fund loans, might end up borrowing instead from China,
potentially increasing China's influence in emerging markets.
According to officials involved in the discussions, the U.S. recently balked
at letting China join the Inter-American Development Bank as a "nonregional
member," something China wanted to do to raise its profile in resource-rich
Latin America. Washington insists that countries such as China that borrow from
the World Bank aren't eligible for such status.
Demonstrating the enormous flexibility its vast reserves provide, China
offered a compromise: For every dollar China borrowed from the World Bank, it
would put an equivalent amount from its reserves into the World Bank through
another doorway.
The deal didn't materialize. A spokesman for the Inter-American Development
Bank says he can neither confirm nor deny that such negotiations took
place.
