China’s $3 trillion: A golden curse?

Tuesday’s Washington Post featured an article on the “$3 trillion dilemma: What to do with all that cash?” They may be dollars, but it’s not U.S. money. The question is in fact about China’s foreign reserves – that surged by another $200 billion in the first quarter of this year to reach new record heights.

This event did not receive the kind of media coverage one might expect and the reasons or that are clear. There’s nothing new about China having more money than virtually anybody else in the world. And that fact doesn’t even matter all that much since China overtook Japan to become the world’s second-largest economy. It is a well-known fact that some languages don’t have precise words for numbers beyond a certain level: instead referring to large amounts as “much” because people simply do not need to be so exact in practice. So, China’s current foreign reserve can also aptly be described as “much.”

Why do they feel so good?

However, that this American newspaper mentioned this event at all is worthy of respect, as are the authors’ efforts to hide their gnawing envy and wounded national pride. This edition of the Washington Post also led with a story on U.S. government debt and an opinion poll about efforts to get out of it.

The piece mentions the fact that the world’s leading rating agency Standard Poor’s has changed its outlook on the creditworthiness of U.S. government bonds from stable down to negative. The agency also warned the American government that the country risks losing its AAA rating if nothing is done about the huge government debt. Meanwhile, the poll indicated that Americans opposed the cuts that the Obama administration proposed to cure this chronic debt problem. That is only natural, after all, nobody likes austerity measures.

It is not hard to understand why Americans feel like this. They have grown accustomed to being the world’s best and first in all areas of life. Then, by historical standards almost overnight, they learn that they have the largest and worst government debt in the world ($14 trillion), while the Chinese are sitting on a golden mountain of cash reserves. Now the issue “How come they have it so good if it’s so hard for us?” is added to the two persistent questions of our time: “where did all this come from?” and “where does all the money go?” Nor is it any great mystery why many in the United States would like to see China stumble and come crashing down. That wishful thinking is often reflected in analysis pieces.

Why having so “much” money is a problem

In fact, these vast foreign exchange reserves are part of China’s very real economic problems, and are currently being soberly discussed in the country. Results of the first quarter of 2011 published recently provoked a flurry of statements in Beijing, which in turn prompted the Washington Post article cited above.

Zhou Xiaochuan, Chinese central bank governor, said that the country’s foreign reserves had gone beyond a reasonable level and become a problem. According to the International Monetary Fund, foreign reserves of $1.5 trillion would have sufficed for the usual purposes, such as providing a safety net in case of crisis. But China will find offloading these excessive reserves far from easy. Injecting this money into national circulation would push prices up and, consequently, devalue the national currency. In fact, the Chinese central bank instead keeps withdrawing money from circulation and socking it under the mattress.

China’s main problem lies in something other countries would consider a sign of having a strong national economy: exports constantly exceeding imports. And since the Chinese government collects foreign currency from business, those piles under the mattress just keep on growing. This policy allows Beijing to keep the Yuan under tight control and prevent it becoming freely convertible. It also helped China come smoothly through two massive global currency crises. But now seems to have run up against a barrier.

This is why China’s government reported, almost proudly, that the country’s economy grew by ‘only’ 9.7% in the first quarter. Fearing inflation, the government will keep trying to slow economic growth. Domestic consumption accounted for 6% of this growth. The fact that for the next five years, China will invest its huge reserves in encouraging this growth was a key outcome of the recent Boao Forum For Asia. Generally speaking, China is gradually transitioning to a consumer society on the European model.

Reserves vs. the void

Tortured by financial problems, the United States and Europe are in a state of eager anticipation: hoping that China’s growing domestic consumption will boost the recovery of European and American industries. Incidentally, for the first time in a long period China closed the first quarter of 2011 with a negative trade balance, meaning that imports grew and foreign currency reserves fell.

Now another problem is taking center stage. The main axis of the global economy, so shaken by the crisis in 2008, was as follows: China produces goods for American consumers to buy with borrowed cash far above their real incomes. China’s reserves grow. However, China’s reserves are not as solid as they may initially seem. After all, they consist of U.S. dollar and euro notes, and U.S. government bonds which are all part of that U.S. debt the country is unlikely to repay. Moreover, the United States is gradually devaluing the dollar to boost exports and depreciate its debt. So, despite the growth in nominal value, China’s foreign reserves’ real value is in fact decreasing.

All this demonstrates how topical the issue that the BRICS leaders tackled at their recent summit in China is: the need for a more equitable and rational financial system. But the creation of any such system remains a long way off.


The views expressed in this article are the author’s and do not necessarily represent those of RIA Novosti.

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