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 user 2006-11-08 at 10:44:00 am Views: 35
  • #16679

    China’s trillion dollar surplus
    November China will achieve a new milestone in its economic development
    when its total foreign exchange reserves reach $1 trillion. As of 1
    October, China’s central bank announced that its reserves were $987bn -
    and they are growing by $18bn each month.That sum is the largest
    holding of foreign exchange reserves in the world – and more than the
    annual value of economic activity in all but a handful of the world’s
    big economies.The huge surplus is a product of China’s success as an
    exporter to the world.China’s trade surplus, the difference between the
    amount it sells and buys from the world, has topped $100bn, with the
    imbalance especially marked with the US.As a result, China receives
    more and more foreign currency each year, which it puts in its
    reserves.But China’s currency reserves are now so large that some
    economists fear they will unbalance the entire global economy.
    on US Foreign currency reserves are generally seen as a good thing – it
    is the lack of reserves that means that countries might suffer runs on
    their currency, as Britain did in the 1970s.But China’s surplus is much
    more than China needs to cover its exports, or pay for its own
    investments abroad.And China has mainly invested its foreign currency
    reserves in long-term US Treasury bonds and other government
    securities.Brad Setser, a former US Treasury official, estimates that
    China now holds $700bn in US long-term bonds, enough to lower US
    long-term interest rates by 1.5% – which helped stimulate the recent
    housing boom.But those holdings are a double-edged sword.If China
    attempted to diversify its holdings, it could cause a collapse in the
    value of the dollar and higher inflation in the US.That would also
    lower the value of China’s own reserve assets – so China is only slowly
    moving out of dollars and into other currencies such as the euro.
    However, it also ties the fate of the US economy to China.

    Worries for China
    economic theory, China’s currency should rise in value since it has
    such a big trade surplus and currency reserves. That would make its
    goods more expensive and cut the trade surplus.But China’s economic
    growth is highly dependent on exports and investment, with relatively
    little coming from domestic consumption.So the Chinese government wants
    to keep the value of its currency, the yuan, fixed at a rate tied to
    the US dollar (with a 3% variation allowed).This helps boost foreign
    investment but makes it more difficult to control inflation.In the long
    term, China wants to switch the emphasis in its economy to domestic
    demand.But that will take time – and in the meanwhile the currency
    reserves could double to reach $2 trillion in a few more years.

    Foreign investment
    economists argue that the pattern actually benefits both the US and
    China. The US gets a cheap and stable source of funding for its trade
    deficit, allowing the economy to continue to grow as consumers purchase
    cheap foreign goods – whose low prices keep inflation in check.And
    China is able to maintain its export-led economic growth, generating
    jobs for its growing urban population, while continuing to attract
    foreign investment.But others argue that it may not be sustainable -
    and the attempt to unwind these huge imbalances could destabilise the
    world economy.Brad Setser believes that unless China rapidly revalues
    its currency, it will face increased pressures on its domestic economy
    - with over-investment (now approaching 50% of GDP) eventually
    collapsing, putting pressure on the banking system.Fred Bergsten of the
    Institute of International Economics argue that the problems of
    adjustment – and the huge trade imbalance – will generate growing
    protectionist pressures in the US and Europe, undermining support for
    free trade.The IMF and the OECD also see this adjustment as the central
    problem of the world economy.And unless it is tackled, the prospects
    for future world economic growth might well be derailed.