Sunday, August 16, 2009

China got a problem in foreign reserves

One country accounts for over 30% of world's total foreign currency reserve (see the chart below). This is not normal.

This huge piles of money can't get back into China, because it will cause inflation. In one way or another, it needs to be "recycled".

The recycling previously took the form of buying US treasuries, partly contributing to the flood of global liquidity and housing bubble. Now after the bubble burst, and the yields on US treasuries almost give nothing in return, China faces a problem in finding its next "dollar recycling" channel.

US government offered to sell inflation-protected treasuries, but China still seems to be very worried about the prospect of the dollar.

There are not many options left on the table. Since when you got the money but you don't know where to spend?

Option 1: acquire foreign assets, especially foreign natural resources to secure the supply of China's high growth. This is what China has been doing, but I am sure it will stir some controversies. Nobody will feel comfortable in selling their natural resources to a country that is non-democratic and to firms largely controlled by the government. Well, you will hear "new colonism", that's for sure.

Option 2: use the dollar to purchase advanced manufacturing and research equipment that will increase China's productivity in the future. This seems to be a smarter way to spend the money, but China faces a lot of import restrictions, mainly from the US. The US policy makers still treat China as a potential rival, not ally. That's the problem.