China’s $3 trillion dilemma: What to do with all that cash?
By Howard Schneider,
BEIJING — What to do with $3 trillion?
Bail out the euro so Europeans can keep buying stuff? Lock up mineral rights around the world? Spend it on imports? Sock it away under a mattress — or in U.S. Treasury notes — and let the pile keep growing?
In what amounted to an acknowledgment that some of Beijing’s core economic policies are causing trouble, Chinese central bank governor Zhou Xiaochuan said this week that the country was, in effect, suffering from too much money. China’s foreign reserve holdings topped $3 trillion in March after increasing 25 percent in the past year alone, a pace Zhou said was feeding inflation and becoming difficult to manage.
“Foreign-exchange reserves have exceeded the reasonable level that our country actually needs,” Zhou said, and the continued buildup adds to the risk of inflation and makes it difficult for the country to manage its monetary policy.
The reserve figure is one of the central barometers of China’s economic relations with the rest of the world — the excess of money flowing into the country for imports and investments. Despite years of talk about the need for more balance, reserves have gone in one direction: up.
According to media accounts, Zhou stopped short of any recommended remedy. But the continued accumulation of reserves is closely linked with the country’s practice of keeping its exchange rate low and relatively stable against the dollar. Zhou’s comments reflect an intensifying dilemma over the trade-offs involved — particularly the risk of inflation and the rising interest rates and other measures that the People’s Bank of China is imposing to try to keep prices under control.
“China has reached a monetary policy stalemate,” in which traditional banking measures have not curbed inflation but authorities are unwilling to let the currency appreciate as another way to address the problem, Glenn B. Maguire, chief Asia economist with the financial services firm Societe Generale, wrote in an analysis Tuesday.
Zhou is considered a reformer on currency and other financial policies, but his is a minority voice. China’s central bank is not independent but answers to a ruling State Council that juggles the sometimes conflicting priorities of the country’s exporters, state-owned companies, local governments and other factions. Zhou is not a council member.
With China facing a pressing and politically sensitive rise in prices, there is debate about the forces involved: whether the country is being flooded by the dollars produced in Washington by the Federal Reserve to stimulate the U.S. economy or creating problems for itself.
The currency policy boosts the fortunes of export companies by keeping prices lower than they otherwise would be. But it also helps maintain a large trade and investment surplus, plus a flow of money being bet that at some point the yuan will rise in value — all components in the growth of China’s reserves. Some here argue that the large stockpile makes little sense in a country with pressing development needs.
With much of the money simply funneled into low-yielding U.S. Treasury securities, “on the whole, we have failed to use these resources to improve living standards,” said Yu Yongding, an economist at the Chinese Academy of Social Sciences and former adviser to the PBOC’s monetary policy committee. “As a developing country, we should not be exporting capital.”
In a recent study, the International Monetary Fund estimated China has accumulated perhaps twice or more the amount of foreign reserves needed for traditional purposes, such as buttressing the economy in a crisis.
It has created a paradox: Despite the store of wealth (the next closest is Japan’s at $1 trillion; open Western nations such as the United States hold comparatively little), China remains deep in the ranks of the developing world, with per capita annual income of $3,000 and extensive rural infrastructure needs that draw the help of such organizations as the World Bank.
The money can’t be easily spent inside the country without adding to inflation but could be used for imports or invested overseas, as some of it is through China Investment Corp., the nation’s sovereign wealth fund. A rising exchange rate would ease the pace of reserve accumulation a different way, by spreading spending power throughout the population.
The situation is a headache for Zhou.
To stabilize the value of the Chinese currency, the dollars coming into China must be drawn back out of the financial system — and in a way that does not expand the local money supply more than authorities wish.
The central bank does that by having China’s major banks turn over foreign exchange in return for interest-bearing central bank securities. Although that keeps the exchange rate steady, it means that capital in effect is locked up in the central bank, where it cannot be lent or put to use in the economy.
Over the past week, the amount “sterilized” totaled more than $12 billion. Between controlling the exchange rate and the rising amounts banks are being required to set aside in the fight against inflation, perhaps a quarter or more of China’s money supply “is now frozen or inactive,” Fan Gang, head of China’s National Economic Research Institute and a former member of the central bank’s monetary policy committee, wrote in a recent essay that advocated both a higher exchange rate and social, tax and other reforms that would raise Chinese household spending.