Wednesday, March 29, 2006

The World's Biggest Forex Reserves

New data reports show that China currently holds the world's biggest foreign exchange reserves, surpassing that of Japan's. Beijing said, however, that this will not change its gradualist approach to currency reform.

At the end of Feruary, China's reserves reached U.S. $853.7 billion, and Japan's was U.S. $850 billion. On the other hand, the United States has a much smaller foreign currency reserve of approximately $38.9 billion.

There had been reports a few months ago stating that China had planned on shifting some of its foreign reserve holdings from the American dollar to some other foreign currencies. Some economists in the U.S. has warned that such actions by the Chinese government could induce fluctuations in the value of the greenback. Not all economists, however, anticipate negative repercussions for the U.S. economy. Were China and Japan to engineer a significant fall in the dollar, those nations also would suffer the consequences -- sharply diminished exports as Americans lose spending power, plus a drop in the value of their dollar assets. This could be an incentive for China to hold on to its American dollars.

Currency exchange rate can have considerable bearing on trade balance sheets. While it has been speculated that, with the unpegging of the yuan, the U.S. trade deficit with China would be reduced, data has shown that it has not happened as expected. Some economists have noted that the reduction of trade imabalance between the U.S. and China is a collaborative effort. While China was to float the exchange rate, the United States should also look into structural issues such as savings rate and active reduction of its deficits.

Chinese policymakers have justified the increased foreign exchange reserves with a few observations. The high reserves held by China, Japan and other Asian economies was a result of the Asian financial crisis in 1998. It is also noteworthy that Asian economies have saving regimes that favor savings much more so than consumption. While some of the increased reserves came from trade imabalance with the United States, some of them also came from increased foreign direct investment from American companies. Finally, on balance, the reserves on a per capita level are not all that high.

With the U.S. Congress aiming to pass policies to reduce the trade deficits, this news comes as yet another incentive for politicians to consider drastic measures against a free market solution to China's continuous rise.

Financial Times, China Forex Reserves World's Biggest, Report Says, March 28, 2006.
Washington Post, China Set To Reduce Exposure To Dollar, Move Would Probably Push Currency Down, January 10, 2006.
International Monetary Fund, Data Template on International Reserves and Foreign Currency Liquidity (U.S. data)

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