Shrinking dollar reserves signal China’s growing global integration

(From Mercator Institute for China Studies)

By Rolf J. Langhammer

Investors’ fears over China selling off its foreign currency reserves are short sighted. Rather than signalling an impending crisis, the development shows that China is now investing globally and that the yuan is on track to become an international currency.

One of the hottest bets in today’s financial markets is over the question of how long China can keep selling US dollars (USD) before the People’s Bank of China runs dry. At the rate at which the central bank currently employs the country’s once legendary currency reserves to defend the Chinese yuan (CNY) against an unwelcome speed of depreciation, some investors are betting on less than three years.

This assessment is a symptom of the economic myopia that so often befalls financial markets. Until recently, China was scolded for its extraordinarily high level of reserves, which were seen as an indicator of currency manipulation and exchange rate protection. These complaints have now been replaced by concerns that China’s reserves could be exhausted and trigger a new financial crisis in China and beyond.

File picture illustration taken in Beijing, China shows Chinese 100 yuan banknotes and a U.S. one dollar banknote

China’s reserves are still unrivaled

But like there was no reason to panic in light of China’s massive build-up of reserves, there is no reason to be overly concerned about the opposite trend. First of all, let’s keep in mind that the level of Chinese currency reserves may have dropped considerably, but that it is still unrivalled. China’s reserves dropped from covering 26 months of imports in October 2015 to 22 months of imports in March 2016. This level is still far above the average level of currency reserves in OECD countries. The European Central Bank’s reserves would only cover about 1 month of imports, while the level of Australia’s reserves are considered high at about 3 months worth of the country’s import volume. Nobody would argue that the reserve levels in these two economies indicate a coming crisis.

When markets now worry about the decline of China’s reserves – which admittedly occurs at extraordinary speed – they disregard the context in which this dramatic shift occurs. Rather than announcing an imminent crisis, its dwindling reserves symbolise the China’s increasingly successful integration into the world economy. Fewer dollars in China’s official coffers indicate that the yuan begins to mature into a truly international currency and that China is now a “global equity investor” with worldwide production facilities rather than being the world’s factory.  Read more




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