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.
China’s economy is the world’s second biggest, with a $5.8 trillion gross domestic product that eclipsed Japan in 2010. Will China pass the United States? When?
China’s foreign reserve holdings topped $3 trillion in March.
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.