from Follow the Money

Heading toward a trillion

January 15, 2006

Blog Post
Blog posts represent the views of CFR fellows and staff and not those of CFR, which takes no institutional positions.

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I am talking about China's reserves, not the US current account deficit.  Both are likley to approach $1 trillion in 2006.

Today, we learned that China's reserves soared in December, and now total $819 billion.   The FT:

China's foreign exchange reserves grew nearly $50bn in the last quarter of 2005 to reach $819bn, putting its reserves on track to surpass Japan this year as the world's largest. The increase of $209bn in China's reserves last year, slightly higher than the $207bn rise in 2004, came as a soaring trade surplus offset a decline in inflows of speculative capital from investors betting on a revaluation of the renminbi.

Seems to me like speculators resumed betting on the RMB's rise.  Reserves rose by $25 billion (end November reserves were reported at $794.2 billion); the trade surplus was only $11b.

Actually, I don't think speculators' stopped betting on the RMB in October/ November so much as the combination of valuation losses and the currency swap cut into China's reserve growth in October and November, creating the perception that speculative pressure eased.

As far as I know, China didn't experience big valuation gains or big valuation losses in December.  I think the euro/$ and yen/$ ended December pretty close to where they were at the end of November  (I am in a rush - I'll check later).   

But China certainly did experience valuation losses in the fourth quarter, so if you adjust for valuation and the currency swap, China's q4 reserve accumulation almost certainly was above $60 billion. 

That means there was no slowdown in speculative inflows this quarter, or at least not much of one, despite all the talk of slowdown after the October and November data.

And the same is true for the year as a whole.  Once you adjust for valuation effects, the "fall-off" in speculative inflows is smaller than many argue.

Ballpark, valuation probably subtracted $30b from China's reserves in 2005, and added $15 billion to China's reserve growth in 2004.  Which implies that total reserve accumulation - adjusted for valuation - was quite a bit stronger in 2005 than in 2004.  

Speculative inflows certainly fell in 2005.  But not by quite as much as you would think if you don't adjust for valuation.  And the falloff in speculative inflows wasn't simply because folks lost interest in betting on the RMB.  The government also made it harder to bring dollars into China.  The FT again:

In 2004, the fastest-growing source of foreign exchange for China was so-called "credit transactions" - offshore US dollar borrowings by Chinese companies and foreign banks that were converted to renminbi on the mainland. Such borrowings were driven as much by hopes of a windfall from a revaluation of the Chinese currency as by opportunities to invest in China's surging economy. The government has tightened controls on offshore borrowings during the past year, especially by foreign banks.

I'll do more fine grained calculations in a bit.

Why are so many people betting on the RMB to rise?   US pressure?  Sure, that's part of it.  But not all of it.  The RMB is pretty clearly undervalued.   Set aside China's rapid export growth since 2002 and its now significant current account surplus - a surplus that grew in the face of the oil shock.  The latest evidence comes from the Economist' Big Mac Index.   Look where China ranks!

(Hat tip, the New Economist).

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