Forex reserves exceed US$1 trillion
(AFP)Updated: 2006-11-06 23:01
Mainland banks are swimming in cash because of the huge foreign direct investment flows entering China, while its factories are earning dollars for exports on everything from plastics to electronics.
The problem is the accumulation puts massive upward pressure on the yuan. When the People's Bank of China purchases the forex inflows it must do so with yuan, inadvertently pumping cash or liquidity back into the financial system which then gets loaned out by the banks.
Too many loans lead to indiscriminate investment, which potentially gives way to overproduction and eventually a deflationary crisis develops resulting in financial meltdown.
Standard and Chartered's Green said inflation is the greatest risk China faces but so far, with the rate running under two percent a year, the inflationary consequences of all these inflows has been avoided.
"The strange thing about China at the moment is that we have low, pretty stable inflation." said Green.
While strong inflation may have yet to surface in China, the overgrown reserves open up Beijing to a further risk, greater currency exposure.
Experts worry that China could suffer huge losses if the dollar depreciates or US treasury yields fall, as the dollar-denominated assets are by far the largest portion of the reserve portfolio.
"It's a big challenge to manage the money," Ha Jiming, chief economist with China International Capital Corporation based in Hong Kong.
"The key will be to slow down the reserves growth but it takes time."
"If any central bank that has most of their reserves in dollars -- and that is most Asian central banks... sells a large amount of dollars as a percentage of their reserves, two things are going to happen: One, the dollar is going to collapse, and two, they're going to hurt themselves," said Callum Henderson, head of forex strategy at Standard Chartered in Singapore
"No one is going to offload half of their reserves, it's the stuff of Michael Crichton (novels)."
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