China's Foreign Exchange Reserves Reach a Billion 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.