China's foreign exchange reserves will reach $1 trillion soon, which has been a hot topic both in China and abroad. The Sound of Hope radio network interviewed renowned political and financial commentator Caoan Jushi concerning this issue. A summary of the transcript follows.
China's foreign exchange reserves are going reach $1 trillion, the highest ranked in the world. Is it necessary to have foreign exchange reserves? Of course it is necessary. But having such high reserves is actually a big problem. If we grade the management skills of all the central reserve banks around the world, China's management could be ranked the lowest.
First, it is likely to fuel inflation. Why? People always regard foreign exchange reserves as savings, which would mean China has made a lot of money.
However, foreign exchange reserves bear no relationship to savings. Foreign exchange reserves might be regarded as savings in the case of other countries, but they cannot be counted as savings for China because China's system has an issue: Foreign currency cannot be freely exchanged in China. Every U.S. dollar the Chinese authorities receive is equivalent to the authorities issuing 8 yuan, or it is similar to the Chinese authorities using foreign currency as gold (which has been used as the standard to issue bank notes).
Then $1 trillion in reserves is equivalent to issuing an additional 8 trillion yuan. It is indeed inflation. And thus it is not good for the Chinese people.
Since the Chinese Communist Party took control of China in 1949, it has only issued a total of 21 trillion yuan in total. But in short three years, from 2003 till now, it issued an additional 8 trillion yuan. Everyone can calculate that there has been over 30 percent inflation in that three years' time. The foreign exchange reserves are a major problem. It is a problem with the system, and it is indeed inflation.
Second, where do these U.S. dollars come from? These U.S. dollars are from selling state-owned property and China's resources.
Think about it. The GDP in mainland China is only around $1 trillion. The foreign exchange reserves have increased from last year's over $700 billion to $1 trillion today—an over $200 billion increase in one year. $200 billion is one-fifth of the GDP in mainland China. However the average mainland export profit is between 3 and 4 percent.
Even if mainland's GDP is entirely allocated for exports, the profit is less than $40 billion, far from the $200 billion that I just mentioned. So, where is the money coming from? It is actually from the sale of state-owned property and China's resources. The increase of foreign exchange reserves is not a good thing.
Third, it is a sign of an unstable political situation. Everyone in China knows when a company is run by the Communist Party, it always becomes a money drainer. Hence it wants foreign investment.
According to regulations, foreign investment must be exchanged into yuan to operate inside mainland China. When foreign investment wants to pull out, yuan need to be exchanged back. So the more foreign investment, the more foreign exchange reserves on the communist regime's hands.
The regime is also very cautious in spending or investing this money; it is the assurance of money exchange whenever foreign investment wants to pull out of China in case of political instability.
Theoretically, it is enough to have foreign exchange reserves of about three months' worth of GDP. If calculating from $1 trillion as the mainland's annual GDP, $300 to 400 billion is enough. The rest of the money should be invested inside China.
Now, on the contrary, there are capital shortages everywhere inside the mainland. The regime, on one hand, wants to attract foreign investment (borrow money from overseas), but on the other hand, it is using its foreign exchange reserves to buy U.S. bonds. So I say that the mainland's foreign exchange reserves management skills are entry-level, maybe a little better than some African countries.
Since the CCP invests heavily in U.S. bonds, does that mean it would have a big impact on the U.S. economy? This is also a misunderstanding. This is because in the past, issuing of currency was based on gold. But now, there is no need for the U.S. to do so. The U.S. can print its currency anytime. Currently, the U.S. is adopting the strategy of devaluing the dollar.
What does this mean? Out of the $1 trillion in the communist regime's hands, $700 billion are in U.S. dollars. If the U.S. dollar devalues by 10 percent, then $70 billion in the Chinese foreign exchange fund will have evaporated. The issuing of [U.S.] currency is not within China's control. Hence, China's money is controlled by the U.S.
Ultimately, the problem lies in the currency exchange system. If people are allowed to possess and trade freely in U.S. dollars, there wouldn't be this problem. China is worried that once the people exchange their money for U.S. dollars, the rich would take their money overseas. China's currency would then depreciate and the domestic economy would deteriorate.
Therefore, the foreign exchange reserve is not the government's money. It is not the government's profit or the government's financial revenue. Neither is it government savings. What is it, then? It is the reserve of yuan in circulation. If you have 100 tons of gold, you can issue an equivalent amount of currency. If you sell out your 100 tons of gold, then your currency becomes useless.
There is one view that says that since China is holding a massive quantity of U.S. government bonds, if China sells off the bonds in large quantities, then this may have a serious impact on the U.S. economy. After a massive sell-off, the U.S. dollar will depreciate. But the U.S. has a massive number of commodities that are equivalent to gold. So it can use its strategic reserves to stabilize the dollar. This will serve to minimize the impact.
On the other hand, selling large quantities of U.S. bonds will lead to massive domestic inflation inside China. For instance, originally it has $1 trillion to issue yuan, but now it only has $200 billion to do so. This is equivalent to a disguised form of depreciation for the yuan. This kind of depreciation can have a major impact on the domestic economy and can create social turmoil.
In a nutshell, the state of foreign exchange management in China appears to be in the first or second stage, which is extremely low.
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