US$1 trillion dilemma: What to do with it?
Updated: 2006-11-15 14:23
As official data flash up staggering US$1 trillion of foreign exchange
reserves, China is debating whether the huge stockpile is a blessing or a burden
and what to do with it.
The huge reserves are a reflection of China's
economic achievements since reforms began in the 1980s, but observers worry that
an excessive, fast-growing stash will endanger currency stability and liquidity.
Since 1980, China's foreign exchange reserves have jumped from zero to
US$1 trillion, with rises of more than US$200 billion in each of the last two
The rapid growth of reserves could fuel speculation on the
appreciation of the Chinese currency, or Renminbi (RMB), said Tan Yaling,
research fellow with the China International Economic Relation Association under
the central bank.
The product of foreign trade revenue and foreign
investment, China's huge reserves are a target of international critics, who
argue that the RMB should be revalued, saying that the undervalued yuan gives
Chinese products a price advantage in international markets and hurts
manufacturers from other countries.
However, some economists say the
rapidly growing and reforming Chinese economy needs a huge reserve in order to
protect itself against financial risks created by speculators and possible
"Huge US dollar reserves can deter international
speculators as well as foreign politicians who like to make threats about
economic sanctions," said Yang Yingjie, a PhD in economics and associate
professor at the Party School of the Communist Party of China Central Committee.
Although China is estimated to need only US$600-700 billion to guard
against financial risks, a trillion is not excessive, said Yang, adding that a
stable financial environment is the key to the success of the country's reforms
It is not so much the quantity as the structure of the
reserves that is of concern, said Tan.
She said the government should
consider diversifying the foreign currencies held in reserve, but added that it
will be hard to challenge the dominance of the US dollar in the next three to
five years, as the United States continues to set the pace for the global
"The United States is the largest manipulator of foreign
exchange rates," said Liu Yihui, researcher at the Institute of Finance &
Banking (IFB) with the major official think tank Chinese Academy of Social
Sciences, noting that the superpower can eschew debt and provoke reserves losses
in other countries by devaluing the dollar.
Zhou Xiaochuan, governor of
China's central bank, said Friday that China is pursuing a more diversified
forex reserves portfolio, triggering a slump of the US dollar in exchange
"We are doing something about foreign exchange reserves," said
Yu Weibin, an expert with the IFB, while declining an interview request.
What should be done with the reserves?
Some experts recommend
buying foreign high-tech equipment and strategic materials like oil and
farmland, supplementing pension funds or supporting public services such as
education, medical care and conservation.
However, others argue that
such choices may fan inflation risks, because the central bank may have to spend
more RMB to keep exchange rates stable.
Wu Xiaoling, deputy governor of
the central bank, has stated that forex reserves cannot be consumed with
impunity, pointing out that the RMB must be used to pay for the reserves.
Wu counseled investing the reserves in state-owned banks, especially
listed ones, as previous experience showed that this would preserve and increase
the value of the reserves.
Liu argued that part of the reserves should
be used to buy oil, gold, silver and other rare metals as a hedge against dollar
"The central bank has to consider monetary policy, but the
reserves are a national resource that need to be proactively managed," said Tan.
She said the government should relax restrictions on foreign exchange
held by individuals and enterprises.
Foreign experts and organizations
like the International Monetary Fund have also suggested a free floating
exchange rate system and the lifting of foreign exchange restrictions but Liu
disagreed, pointing to risks of turbulence that would require even larger forex
reserves for financial security.
"In the long term, China should reduce
the excessive growth of forex reserves by adopting a different mode of economic
growth, but stable exchange rates are necessary if the market is to fully play
its role in adjusting the economic structure," said Liu.
As the debate
rages on, China's State Administration of Foreign Exchange (SAFE) has decided to
recruit 30 more staff members for its Reserves Management Department, bringing
the total number of staff to 200, according to the China Business News. Each of
them is in charge of about US$5 billion.
Having a trillion US dollars is
indeed a blessing, but managing it is quite a burden.
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