China aims to spend $200bn of reserves

[Tet]

By Zhou Jiangong

SHANGHAI - The Chinese government is taking action to implement a new policy of diversifying the disposal of the country's over US$1 trillion foreign exchange reserves which was initiated by the Central Conference on Financial Affairs three weeks ago.

The Ministry of Finance (MOF) is planning to issue yuan-denominated bonds to raise funds that will be used to "buy out" as much as $200 billion from the country's foreign reserve pool.

To take funds out of the foreign exchange reserves the government must pay the equivalent amount in yuan to balance the books.

At the current exchange rate, the total amount of yuan bonds to be issued by the MOF will be more than 1.5 trillion yuan. The ministry plans to sell the bonds to commercial banks, according to China Business News, a leading business newspaper based in Shanghai.

The $200 billion "bought out" from the foreign exchange reserves will then be injected into a new company to be set up this year to handle overseas investment with foreign reserves.

The new company, tentatively named National Foreign Exchange Investment Company, will be controlled by the State Council, China's cabinet. It will spend funds from the foreign reserves on mergers and acquisitions of overseas businesses, including foreign financial institutions. It will also target overseas energy assets and will likely acquire equities in the domestic markets, or even lend money to help finance domestic research and development projects.

Informed sources say that Lou Jiwei, currently vice minister of finance, will be appointed as board chairman of the National Foreign Exchange Investment Company.

The new company will be a ministry-level body and as such its creation needs to be rubber-stamped by the National People's Congress (NPC), China's parliament. According to Chinese law, bond issuance by the MOF also needs the NPC's approval. Therefore, both the establishment of the investment arm and the issuance of bonds are expected to be on the agenda of the NPC's annual session, which begins next month.

If the MOF decides to issue yuan-denominated bonds, which could happen this year, 1.6 trillion yuan would be taken back from the market.

The new company represents a victory for the Ministry of Finance in the battle for foreign exchange assets management. Some researchers close to decision-makers estimated that the new company could manage about $200 billion.

The new policy to diversify the disposal of the country's huge yet growing foreign exchange reserves is also bound to change China's current foreign exchange management regime, which is dominated by the State Administration of Foreign Exchange (SAFE).

According to the People's Bank of China, (PBoC), the central bank, the SAFE is responsible for the stewardship of the largest foreign exchange reserves in the world. It is estimated that over 60% of the reserves are invested in US Treasury bonds, with an annual return rate of about 3.5%.

It is risky to put all eggs in one basket. Also, the expected appreciation of the yuan is worrying the Chinese government. If the US dollars depreciate against the yuan by 5% this year, which is almost certain, the reserves will "shrink" by $50 billion against the yuan, equivalent to the amount of capital the Central Huijin Investment Co has injected into Industrial and Commercial Bank of China (ICBC), Bank of China (BOC) and China Construction Bank (CCB).

Such concerns finally prompted Beijing to decide to reform the management of its foreign exchange reserves.

It is now widely speculated in Beijing financial circles that the SAFE's dominance in the foreign exchange regime will be cracked. The MOF, along with the PBoC, will lead an emerging multi-tier foreign exchange reserve management system.

Meanwhile, the SAFE will also set up an overseas company to prudently invest in low-risk, long-term Treasury bonds and housing mortgage bonds denominated by the US dollar and the euro. The SAFE will still control at least 60% of the $1 trillion reserves after the diversification.

Central Huijin, nominally the PBoC's investment arm, will continue to manage tens of billions of reserve dollars it has injected into three of the "Big Four" state lenders: ICBC, BOC and CCB.

This year, it is estimated that Central Huijin will inject about $25 billion to $30 billion into the last of the "Big Four", the Agricultural Bank of China (ABC), to help restructure it into a joint-stock corporate in preparation for going public. ABC's restructuring is to be decided at the Central Conference on Financial Affairs.

Reserve dollars have helped Central Huijin emerge as an empire of state financial asset control. It also controls the country's biggest securities brokerages and indirectly controls the biggest mutual funds. Central Huijin has just announced that it will inject $4 billion into the China Reinsurance Group to take a 92% controlling stake, while the MOF is taking the remaining 8%.

The National Social Security Fund (NSSF) headed by former minister of finance Xiang Huaicheng is also eyeing a slice of the foreign exchange reserve. But a suggestion that a chunk of the reserve be allocated to the NSSF was firmly rejected by Wu Xiaoling, the deputy governor of PBoC. In general, the idea of allocating part of the reserve to any existing financial institution or government department for the purpose of investment has been discarded.

The scale of the MOF's planned bond issuance is so huge that it has to be done phase by phase. In so doing, pressure on market liquidity can be alleviated. Although the market is awash in liquidity, the issue needs to be in line with monetary policy.

Some analysts suggest that the government adopt a Japanese practice: the Ministry of Finance issues home-currency denominated bonds to buy foreign exchange flowing into the country. The purpose of the policy is to separate the burgeoning money supply from the increasing foreign exchange reserves.

The Japanese Ministry of Finance is responsible both for fiscal policy and monetary policy. But the mandates of the MOF in China are limited to fiscal policy and the supervision of financial assets management. The PBoC oversees monetary policy. Yet the issuance of government bonds concerns both the country's fiscal and monetary policy. Therefore, it requires improved coordination between the MOF and the PBoC, whose relationship has long been tense.

The market is also worried that the MOF could incur losses from the operation since it risks holding hundreds of billions of US dollars that will likely depreciate in coming years. But analysts in Beijing policy circles believe that the government is considering hedging the risk.

They say that with the MOF's bond issuance, more than 1.5 trillion yuan will be drawn from the country's banking system to reduce commercial banks' liquidity.

However, some analysts point out the potential shock effect the operation could have on the stock markets. If 1.5 trillion yuan is absorbed by the bond issuance, the market could face a "liquidity shock".

Many concerns have surfaced. Can the markets bear the shock? Will the purchase of $200 billion be completed in one year or in three years? What will the terms of the bonds be?

Ha Jiming, chief economist at International Capital Corporation Limited, dismissed this concern. "Nowadays, liquidity inside the banking system is more than sufficient. If the government bonds are issued phase by phase, the due bank notes issued by the PBoC and the new base money from the purchase of the foreign exchange will allow the market to absorb the pressure."

If the 1.5 trillion yuan is drawn from the banking system in three years, the market could bear the impact on liquidity, many analysts say.

http://www.atimes.com/atimes/China_B.../IB03Cb09.html

Looks to me like China is getting ready to set a few more countries free from the World Bank, IMF and the Paris Club to name a few. Buying up d0llar assets in foreign countries and converting them to other currencies and buying up foreign debt and converting it to other currencies. TWT, but that is certainly how China set free Argentina and Brazil a couple of years ago.

[jk]

Re: China aims to spend $200bn of reserves

this is another step in the "diversification of reserves" that numerous chinese officials have mentioned. at the end of the day, chinese institutions will have 200billion fewer u.s. dollar denominated bonds, and in place of those dollars hold interests in non-dollar foreign equities, non-dollar bonds, and real assets, e.g. energy. this has to be bad news for the dollar, because it represents an increase in velocity- instead of the dollars being tied up in a treasury or gse bond, the sellers of those equities, energy assets, etc, will get dollars that are liable to be "hotter" in terms of active flows.

[grapejelly]

Re: China aims to spend $200bn of reserves

Since the Chinese banks are said to be the ones who will buy the bonds and issue the renmimbi, this is inflationary, not deflationary, no? Won't the banks be monetizing another $200 billion in bonds one way or another? What am I missing here in terms of Chinese domestic inflation?

[Tet]

Re: China aims to spend $200bn of reserves

this is another step in the "diversification of reserves" that numerous chinese officials have mentioned. at the end of the day, chinese institutions will have 200billion fewer u.s. dollar denominated bonds, and in place of those dollars hold interests in non-dollar foreign equities, non-dollar bonds, and real assets, e.g. energy. this has to be bad news for the dollar, because it represents an increase in velocity- instead of the dollars being tied up in a treasury or gse bond, the sellers of those equities, energy assets, etc, will get dollars that are liable to be "hotter" in terms of active flows.

Article states If the US dollars depreciate against the yuan by 5% this year, which is almost certain, the reserves will "shrink" by $50 billion against the yuan

I'm not sure what bad news for the d0llar means. If by bad news you mean the Federal Reserve and the Bank of the England can't continue to tax the rest of the world with a depreciating currency I agree. The Chinese believe if they do nothing the d0llar falls 5% and they lose $50 billion. Looks to me like the Chinese have decided to do something and are going to use $200 billion to make their $800 billion of reserves that they still hold worth more not less. Uncle Buck gets stronger according to the Chinese not weaker. Buying up US d0llar lending banks or US d0llar loans and then have those banks lend money in another currency lessens the supply of d0llars and doesn't increase them. My read is a stronger Bonar.

[Tet]

Re: China aims to spend $200bn of reserves

Since the Chinese banks are said to be the ones who will buy the bonds and issue the renmimbi, this is inflationary, not deflationary, no? Won't the banks be monetizing another $200 billion in bonds one way or another? What am I missing here in terms of Chinese domestic inflation?

Venezuela is making the same move, they believe that by taking excess money in the economy and putting them into bonds that will reduce the domestic supply of money and thus reduce domestic inflation. I would think the Chinese have the same problem and are looking for a similar result.

[medved]

Re: China aims to spend $200bn of reserves

In essence China agreed to revalue its currency by 5% this year, so if you read claims to the contrary in some articles, e.g. http://globaleconomicanalysis.blogsp...trike-out.html this is patently wrong. The very reason Chinese called Bernanke and Paulson on the carpet, is they had to agree to devalue the dollar and, in return, wanted to kick some american butt. So yuan is going 5% higher this year against the dollar.

However, it does not mean, dollar will go lower against other currencies. $US devaluation is an obvious american policy, and "strong dollar" is just a lip service. Hold on to your gold.

m.

[jk]

Re: China aims to spend $200bn of reserves

Article states If the US dollars depreciate against the yuan by 5% this year, which is almost certain, the reserves will "shrink" by $50 billion against the yuan

I'm not sure what bad news for the d0llar means. If by bad news you mean the Federal Reserve and the Bank of the England can't continue to tax the rest of the world with a depreciating currency I agree. The Chinese believe if they do nothing the d0llar falls 5% and they lose $50 billion. Looks to me like the Chinese have decided to do something and are going to use $200 billion to make their $800 billion of reserves that they still hold worth more not less. Uncle Buck gets stronger according to the Chinese not weaker. Buying up US d0llar lending banks or US d0llar loans and then have those banks lend money in another currency lessens the supply of d0llars and doesn't increase them. My read is a stronger Bonar.

i think the idea is that instead of losing 5% of $1t, or $50b, they will convert $200b into other - non-dollar - kinds of holdings, and so only lose 5% of $800b, or $40b, on their reserves. dollar gets weaker because it's the old maid - no one wants to hold it. as more individuals and institutions make decisions like the chinese - i.e. decide they'd prefer to get out of the dollar and into other kinds of non-dollar assets, velocity rises. the effective money supply is quantity x velocity. there are plenty of mechanisms contributing to quantity on any money supply measure, but the real kicker is a change in velocity.

[Tet]

Re: China aims to spend $200bn of reserves

i think the idea is that instead of losing 5% of $1t, or $50b, they will convert $200b into other - non-dollar - kinds of holdings, and so only lose 5% of $800b, or $40b, on their reserves. dollar gets weaker because it's the old maid - no one wants to hold it. as more individuals and institutions make decisions like the chinese - i.e. decide they'd prefer to get out of the dollar and into other kinds of non-dollar assets, velocity rises. the effective money supply is quantity x velocity. there are plenty of mechanisms contributing to quantity on any money supply measure, but the real kicker is a change in velocity.

D0llar only needs to get back to where it was five years ago and the $800 billion the Chinese would still hold is worth more than the $1 trillion they hold today. Plus China still would hold $200 billion of what used to be d0llar denominated assets, or by buying d0llar based loans from Nigeria, Zambia, Ecuador, Bolivia, etc the Chinese could in effect wipe out hundreds of billions of future d0llar demand, making the d0llars still in circulation worth more.

Let's watch and see if Russia does something similar. Russia has $300 billion in foreign reserves and a inflation rate of 9%. Wouldn't surprise me to see Russia take $60 billion of their reserves and issue a 1.2 trillion Ruble bond and go out and buy up some d0llar assets and go und0llarize some future allies IMF, World Bank and Paris Club loans by paying them off. Russia's stock market just hit $1 trillion in value, I would think they need an offsetting $1 trillion in bonds.

[grapejelly]

Re: China aims to spend $200bn of reserves

The bonds are held as local currency assets that can be used, presumably, as reserves on which to lend local currencies. The banks are paying interest on these and they will want to make new loans for multiples of the face on the bonds. So isn't it long term inflationary?

Also, if there is a rush to buy US$ assets, isn't this the same as getting out of the dollar, and could this be the rush to the exits that puts paid to the dollar for good?

This can't be good for the US$ because it is in essence dumping the US$ and as we all know, when one CB does it, the others will want to do it.

It will also contribute to the asset inflation with hundreds of billions chasing equities and real estate, and drive up interest rates by draining the bond market of US$.

[Tet]

Re: China aims to spend $200bn of reserves

The bonds are held as local currency assets that can be used, presumably, as reserves on which to lend local currencies. The banks are paying interest on these and they will want to make new loans for multiples of the face on the bonds. So isn't it long term inflationary?

Depends what you spend it on. China's roadmap is pretty clear, December they started construction on another Three Gorge Project for hydro-electricity, I would think the price tag would be $30 billion US, about 240 billion Yuan. China has a 15-year plan to build 50 nuclear power plants, I would think the price tag on each is $3 billion US, 25 billion Yuan, despite the contract to Japan for this, most of these plants will be built by Chinese firms. China would like a blue water fleet, complete with a few nuclear powered subs to protect their oil interests, I would think that's a considerable investment. China just announced their own home grown jet that rivals the Eurojet, with their own homegrown air to air missiles, putting this into production will require a lot of cash. Deep water drilling for oil will require a considerable investment as well, China would like solar power to provide 15-20% of their urban power requirements, that will require a large sum of cash. They'd like wind power to provide 2-5% of their total power needs. Looks like China believes the cash is already in the economy, I don't view these expenditures as inflationary.

Also, if there is a rush to buy US$ assets, isn't this the same as getting out of the dollar, and could this be the rush to the exits that puts paid to the dollar for good?

I believe it depends on which assets you purchase, I seriously doubt China is going to come buy golf courses in the US. There are plenty of foreign US d0llar assets that can be bought, I would think a lot of these will be financial assets and those assets will no longer be making d0llar denominated loans. These purchases flow back to the US/British banks as liabilities in the form of cash. There's plenty of US bonds for these banks to purchase.

This can't be good for the US$ because it is in essence dumping the US$ and as we all know, when one CB does it, the others will want to do it.

I don't view spending as dumping, I'd view trading these d0llars for other currency as dumping. I think we underestimate just how many d0llars the IMF, World Bank and the Paris Club create, they are lending to countries not consumers and if nobody is borrowing than d0llar creation should go down considerably.

It will also contribute to the asset inflation with hundreds of billions chasing equities and real estate, and drive up interest rates by draining the bond market of US$.

Cash is a liability for a bank, interest rates will go lower in order for these banks to get rid of the liability. Should be interesting to watch how the buyer of last resort, the Federal Reserve plays this out. Brazil, Argentina, Russia, Venezuela, India, South Africa and maybe South Korea will make similar bond offerings with similar aims in mind. I'd think we were involved in a economic World War, but considering Faux News or our Federal Government hasn't mentioned it I must be wrong.

[jk]

Re: China aims to spend $200bn of reserves

the Chinese could in effect wipe out hundreds of billions of future d0llar demand, making the d0llars still in circulation worth more.

my economics text says that lower demand for a product means lower prices for that product. i.e. lower demand for dollars means lower value for dollars.

also, dollar creation in the form of country loans is very small relative to the dollar creation in derivatives, mortgages, leverage on financial assets, etc. [do the dollar loans the chinese have paid off for imf borrowers add up to what the u.s. spends on chewing gum in a year?] at the same time, official reserves are large enough that if a holder, e.g. china, decides to "unfreeze" the money that's been tied down in treasuries and gse bonds, that money gets hotter. you have ignored what happens to the dollars in the hands of whomever or whatever SELLS the assets that the pboc will buy. there's something people call "hot money," money that changes hands quickly as it seeks quick returns around the world. the pboc's holdings of u.s. denominated fixed income assets have been the antithesis of hot money. it has been the most stable of investments. turning those sums into hot money is a big deal.

[Tet]

Re: China aims to spend $200bn of reserves

my economics text says that lower demand for a product means lower prices for that product. i.e. lower demand for dollars means lower value for dollars.

My studies were more about monopolies and their let's just say their unusual pricing power. Being able to charge whatever price you want is certainly a very competitive advantage, look what it did for the Rockefellers. Looks like the d0llar hegemon, the world's reserve currency is getting some competition, my economics taught me that this lowers prices and in this case would mean a more valuable d0llar.

also, dollar creation in the form of country loans is very small relative to the dollar creation in derivatives, mortgages, leverage on financial assets, etc. [do the dollar loans the chinese have paid off for imf borrowers add up to what the u.s. spends on chewing gum in a year?]

Wow, that's a lot of chewing gum, no wonder the Wigleys had so many mansions. As an example, a little country like Ecuador with 13 million people has a foreign d0llar based debt of $11 billion. Now if Ecuador doesn't have this debt, that's about $600 million in interest that Ecuador doesn't have to give away oil and natural gas to pay back. IMF is just like the Federal Reserve and is fractional reserve lending, just a billion d0llar IMF loan can create tens of billions if not hundreds of billions of additional d0llar denominated lending. Ecuador owed the IMF $30 million which they just paid back, this $30 million has created $11 billion in d0llar denominated debt. Pretty amazing.

at the same time, official reserves are large enough that if a holder, e.g. china, decides to "unfreeze" the money that's been tied down in treasuries and gse bonds,

Doesn't appear to be the case according to the article, looks like China is holding $200 billion in actual cash.

that money gets hotter. you have ignored what happens to the dollars in the hands of whomever or whatever SELLS the assets that the pboc will buy. there's something people call "hot money," money that changes hands quickly as it seeks quick returns around the world. the pboc's holdings of u.s. denominated fixed income assets have been the antithesis of hot money. it has been the most stable of investments. turning those sums into hot money is a big deal.

Always fun to watch the Adam Smith, Ayn Rand, Chicago Scool of Business, invisible Free Market hand enter the marketplace. This is where I bet that overpriced shitty stocks become even more overpriced shitty stocks. Between the Federal and State governement, plus Fanny and Freddie they already own all the land and not much left for them to purchase. What's left? Stocks and Bonds? I doubt it's going to be gold and silver.

[vie2233hil]

Re: China aims to spend $200bn of reserves

so what would be a good strategy to hedge against dollar inflation? buy foreign stocks? arent they already overpriced?

[jk]

Re: China aims to spend $200bn of reserves

so what would be a good strategy to hedge against dollar inflation? buy foreign stocks? arent they already overpriced?

everything is already overpriced. but if the dollar loses value, everything will look even more overpriced. if you think there will be inflation you want to buy real assets that are not tied to the credit market [i.e. real estate is suspect], precious metals, strong currencies, income producing foreign assets, commodities.

[vie2233hil]

Re: China aims to spend $200bn of reserves

Are there other examples of real assets not directly tied to credit markets?
What would be an actual proper way to buy commodities? Mutual or closed-end funds investing in commodities or companies producing commodities are assets which are aleady overpriced?