China's Foreign Reserves

Right let's see if I can get this straight as it seems like a very important concept to understand. China's foreign reserves are netted out on it's central bank balance sheet by a corresponding debt. How has this happened?

First thing that happens is China produces widgets that America likes and sells them profitably to. In return the widget maker is given US dollars which he sells and purchases Yaun with. The important point here is that because the widget which was created by labor has been made profitably it results in a net increase in demand for Yaun which would normally cause the Yaun to rise and assuming the US does not do better in it's trade with any other countries the $US dollar would be inclined to fall.

The China central bank notices from it's elevated perch that the profitable manufacturers are driving up the value of the Yaun putting the breaks on it's economic growth. In order to prevent the Yaun from rising it sells Yaun and buys US dollars. But since it did not make anything in a profitable way it must create a corresponding debt on the other side of the ledger or print money to purchase the $US.

There you have it. I think.

Of course there are other processes occurring at the same time. Such as money formation at the regional banks in the form of debts and credits to fund the manufacturers expanding factories. Artificially low interest rates to tax effectively tax savers and help capitalize banks. And using similar methods to the federal reserve to expand it's balance sheet and encourage lending as part of it's fiscal stimulus measures.


Here is a better explaination fo China's foreign reserves by Hua Qiao from

http://mpettis.com/2010/02/never-short-a-country-with-2-trillion-in-reserves/#comment-4827

Chinese exporters sell to US consumers for dollars. China, through the PBOC and SAFE (State Agency of Foreign Exchange), controls the Yuan by being the only market agent for that exchange, currently pegging the Yuan at 6.83 for every dollar. So for every $1 tendered, the exporter gets 6.83 RMB deposited into his bank account.

PBOC takes the dollars, transfers them to CIC or some other investment entity, and invests them back into vehicles in the west, typically treasuries. They could sell the dollars in the world market for some other currency. They could buy physical assets with the US dollars. But China has to date, bought principally US Government debt.

Back home in China, the PBOC must effectively print more RMB to cover the deposit, increasing the money supply. If they want to offset the inflationary effects of that increase, they issue sterilization bonds which they require the banks to buy. They were pretty much doing so up until 2008 when they stopped.

So, are these foreign exchange assets wealth? Probably not the right question to ask. Clearly, the reserves are an asset that China, as a country, can use to project its influence on the international stage. But that asset comes at the expense of improving Chinese citizen’s lot at home. If the increase in RMB supply is not sterilized, then inflation will eat away at the value of those deposits the exporters and hardworking laborers have stuck at the banks. If the sterilization bonds are issued, then the government is essentially directly borrowing those deposits from their citizens to “invest” overseas.

FX reserves are an asset, just like anything else. However, they represent a redistribution of income/wealth. China is sort of rearranging its national balance sheet. So the Chinese consumer cannot enjoy the fruits of his labor as much as he should because his cash is stuck in low yielding deposits and some of the foreign goods he would like to buy are prohibitively expensive because of the undervalued RMB and also the import duties on foreign goods. Try to buy a REAL set of Ping golf clubs, or a foreign produced car, or imported perfume, foreign vitamins, or foreign makeup or foreign wine here.

As long as you have a pliant population, who you can feed a constant flow of propaganda that their country is well off, the government is working hard for them and tomorrow will be better than today, then they tolerate the hidden costs and the forced savings.