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Tuesday 28 October 2008
China Neither Knight Nor Ogre in This Crisis
As the financial crisis has deepened, the world's attention has increasingly focused on the mainland and its fast-growing US$1.9 trillion pot of foreign exchange reserves.
As the financial crisis has deepened, the world's attention has increasingly focused on the mainland and its fast-growing US$1.9 trillion pot of foreign exchange reserves.
Some observers look to China as a knight in shining armour, hoping Beijing will ride to the rescue by using its trillions to recapitalise the world's battered banking system.
Others fear the country as an evil ogre, worrying that Beijing could skewer the United States' bailout plan by refusing to buy more US Treasury debt.
Both such hopes and fears are nonsense.
From the way some commentators talk about mainland foreign reserves, you could be forgiven for thinking that President Hu Jintao is sitting on a mountain of cash that he can dispose of however he wants.
Well, US$1.9 trillion is certainly a large amount of money. If it was stacked up in US$1 bills, the pile would reach halfway to the moon. But just because US$1.9 trillion is a lot doesn't mean it is available to be spent as Mr Hu chooses.
Foreign reserves are not ready cash. They are assets on one half of a central bank's balance sheet, offset by liabilities on the other side. In this case, that means all the notes and coins in circulation, together with the short term yuan-denominated debt issued by the People's Bank of China to finance its purchases of foreign currencies.
As a result, foreign reserves have not traditionally been invested in order to maximise returns but have rather been held in the safest, most liquid form possible - typically US government debt - to ensure they are available to meet any potential claims on the central bank.
Granted, not even the most conservative analysts think the mainland needs to hold all its US$1.9 trillion in liquid assets. By the most prudent standards imaginable, Beijing still has around US$500 billion more than it needs to keep in liquid government bonds.
Some commentators argue that the extra money should be used to prop up the world's tottering financial system.
On closer examination, however, the proposal doesn't add up. Starting last year, Beijing did attempt to diversify a portion of its foreign-exchange reserves, creating the US$200 billion China Investment Corp with a mandate to boost returns by investing in riskier assets.
The experience has not been a happy one. As the second of the two charts below illustrates, most big mainland overseas investments - whether made by CIC or other state-linked companies - have fallen steeply in value since inception.
As a result, Beijing has little appetite for selling its US Treasury and other government bonds in order to buy equity stakes in shaky banks. As mainland reserve managers have discovered, that would be a risky course of action.
It would be far safer to use foreign governments as intermediaries, which is exactly what Beijing is doing: lending money to governments by buying their bonds and allowing them to recapitalise their own banks. The potential rewards may be smaller, but the risks are far, far lower.
But if hopes that Beijing's reserves will be used to prop up a sagging global financial system are unrealistic, so too are fears that scaled back mainland purchases of US government debt could sink Washington's rescue package.
Although the US government will need to borrow a lot of money to fund its bailout plan, and although China is a big buyer of US debt, probably purchasing around US$300 billion worth in the last 12 months, mainland participation in future Treasury issues is not as essential as commonly thought.
That's because ordinary Americans hit by the downturn in asset markets are going to have to save more and spend less in future in order to rebuild their wealth. With much of that extra saving likely to go into government and quasi-government debt, it would only need the average American to save an extra US$1,000 a year - just 2 per cent of income per capita - to fully replace China as a player in the US debt market.
1 comment:
China Neither Knight Nor Ogre in This Crisis
Tom Holland
27 October 2008
As the financial crisis has deepened, the world's attention has increasingly focused on the mainland and its fast-growing US$1.9 trillion pot of foreign exchange reserves.
Some observers look to China as a knight in shining armour, hoping Beijing will ride to the rescue by using its trillions to recapitalise the world's battered banking system.
Others fear the country as an evil ogre, worrying that Beijing could skewer the United States' bailout plan by refusing to buy more US Treasury debt.
Both such hopes and fears are nonsense.
From the way some commentators talk about mainland foreign reserves, you could be forgiven for thinking that President Hu Jintao is sitting on a mountain of cash that he can dispose of however he wants.
Well, US$1.9 trillion is certainly a large amount of money. If it was stacked up in US$1 bills, the pile would reach halfway to the moon. But just because US$1.9 trillion is a lot doesn't mean it is available to be spent as Mr Hu chooses.
Foreign reserves are not ready cash. They are assets on one half of a central bank's balance sheet, offset by liabilities on the other side. In this case, that means all the notes and coins in circulation, together with the short term yuan-denominated debt issued by the People's Bank of China to finance its purchases of foreign currencies.
As a result, foreign reserves have not traditionally been invested in order to maximise returns but have rather been held in the safest, most liquid form possible - typically US government debt - to ensure they are available to meet any potential claims on the central bank.
Granted, not even the most conservative analysts think the mainland needs to hold all its US$1.9 trillion in liquid assets. By the most prudent standards imaginable, Beijing still has around US$500 billion more than it needs to keep in liquid government bonds.
Some commentators argue that the extra money should be used to prop up the world's tottering financial system.
On closer examination, however, the proposal doesn't add up. Starting last year, Beijing did attempt to diversify a portion of its foreign-exchange reserves, creating the US$200 billion China Investment Corp with a mandate to boost returns by investing in riskier assets.
The experience has not been a happy one. As the second of the two charts below illustrates, most big mainland overseas investments - whether made by CIC or other state-linked companies - have fallen steeply in value since inception.
As a result, Beijing has little appetite for selling its US Treasury and other government bonds in order to buy equity stakes in shaky banks. As mainland reserve managers have discovered, that would be a risky course of action.
It would be far safer to use foreign governments as intermediaries, which is exactly what Beijing is doing: lending money to governments by buying their bonds and allowing them to recapitalise their own banks. The potential rewards may be smaller, but the risks are far, far lower.
But if hopes that Beijing's reserves will be used to prop up a sagging global financial system are unrealistic, so too are fears that scaled back mainland purchases of US government debt could sink Washington's rescue package.
Although the US government will need to borrow a lot of money to fund its bailout plan, and although China is a big buyer of US debt, probably purchasing around US$300 billion worth in the last 12 months, mainland participation in future Treasury issues is not as essential as commonly thought.
That's because ordinary Americans hit by the downturn in asset markets are going to have to save more and spend less in future in order to rebuild their wealth. With much of that extra saving likely to go into government and quasi-government debt, it would only need the average American to save an extra US$1,000 a year - just 2 per cent of income per capita - to fully replace China as a player in the US debt market.
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