*NEWS*CHINA’S TRILLION DOLLAR SURPLUS

[Anonymous]

China’s trillion dollar surplus
In
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.
Grip
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
In
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
Some
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.

[Author]

November 8, 2006 at 10:44 AM