Vicious Economic Cycle Leads to China’s Record High Foreign Reserves

October 24, 2011 9:14 am Last Updated: October 1, 2015 3:18 pm
An elderly man walks past a poster advertising the renminbi (RMB) currency (Chinese yuan) in Hong Kong on Aug. 18, 2011.  (Laurent Fievet/AFP/Getty Images)
An elderly man walks past a poster advertising the renminbi (RMB) currency (Chinese yuan) in Hong Kong on Aug. 18, 2011. (Laurent Fievet/AFP/Getty Images)

China’s foreign exchange reserves reached a record US$3.2 trillion at the end of September, according to the latest statistics from China’s Central Bank, and many Chinese are now asking why this huge hoard of cash can’t be used to help the people in China.

On Oct. 17, the state-controlled People’s Daily published an article titled “Whose money is our foreign reserve? Can it be spent?”

The article quotes experts to argue that, “Foreign reserves belong to China’s central bank, and also represent the Nation’s wealth, but they can’t be interpreted as Chinese people’s ‘blood money,’ and can’t be used freely.”

This article says the foreign currency generated by China’s enterprises and individuals are sold to China’s central bank for RMB. Therefore, foreign-exchange reserves become an asset of the Central bank, generated through the liabilities method. Freely distributing the money to ordinary people will cause serious consequences, the article says, including inflation and even the bankruptcy of the Central Bank.

For a long time the state has been implementing a policy of rewarding export and limiting import, of loosening inflow and tighten outflow of foreign currency, the article says. Also, because the RMB have the potential to appreciate, enterprises and households in China don’t like to hold on to foreign currency.

All of these factors have been pushing a rapid increase in the amount of foreign reserves held.

Export-Oriented Model’s Failure

Dr. Cheng Xiaonong, a US-based China economist and the chief editor of Modern China Studies, said, in an interview with The Epoch Times, that the huge foreign reserves can be traced to China’s export-oriented model. Cheng states that a large and populous nation like China cannot rely on an export-oriented economy, for two reasons:

First, a country with a huge population also has a big labor market. If the majority of labor in the country is engaged in export production, it’ll excessively seize the markets of other countries.

Second, a highly populous country should be a major consumer market. If the salaries are increasing normally, most of this country’s products can be consumed domestically, and there would then be no need to rely on exports.

China’s economic growth has hinged it being the world’s factory and attracting foreign investment with low salaries. In the process, China was turned into a country with a weak consumer market so that a major portion of the products made in China must go abroad to find a market.

Cheng explained how China’s economy is caught in a vicious circle that leads to the growth of China’s foreign reserves.

Although China has been on the fast track of economic growth, the majority of the laborers are still poor, Cheng said. Foreign reserves are rapidly rising, accompanied by increasing inflation.

Domestic enterprises, at the same time, have jumped into real estate opportunities, increasing housing prices, Cheng said. The increase in commodity and housing prices has, in turn, further reduce the buying power of average people.

China must then lean more on exports, which leads to a further swelling of its foreign reserves, and a new wave of inflation, Cheng said.

Economist Qi Yanchen said the size of China’s imports is not insignificant but it fails to lead to a drop in commodity prices. The reason, he says, is imports are monopolized by domestic interest groups to gain huge profits.

China’s domestic refined oil price, for instance, is much higher than the average international price. In terms of basic economic theory, commodity prices should decrease due to more products on the market from increased imports, and ordinary people should reap benefits from it.

But the situation in China now runs contrary to common sense economics—the more goods are imported, the greater the exploitation suffered by the ordinary Chinese people.

Cheng states China’s enterprises use their products and labor service to obtain U.S. dollars. This should enable the Chinese people to buy products and services on an international market.

But, the Beijing government forcibly controls the foreign currency and has taken away the basic rights of its own people. In essence, a government has made those foreign dollars obtained by enterprises and individuals into a look-but-can’t-touch entity.

Domestic inflation is quite serious right now, and the bank savings rates are on the lower end as well. Most people want to find a safe, value-added investment method. One possibility is to allow foreign banks and investment agencies to serve Chinese people, who could be able to buy foreign stocks and bonds. Beijing has this possibility thoroughly blocked.

Cheng believes the obvious route would be to remove the control on foreign currency, and let people freely invest overseas. But, people tend not to trust the Chinese Communiist Party (CCP). If the control on foreign currency is lifted, people will transfer all their money overseas. So the CCP doesn’t dare relax its control on foreign currency.

Foreign Reserves for the People

Qi is one of the economists in China who argues that the foreign reserves can be distributed to the people.

He believes free distribution of the foreign reserves cannot cause inflation. If people have money, he said, they will mostly spend it overseas—it’s like importing goods.

Hu Xingdou, professor and economist from Beijing Institute of Technology, stated in a microblog-post that he considers nonsensical the idea that easing the government’s control on foreign exchange reserves would lead to inflation.

“One should change from forcing the settlement of foreign currency, to voluntary settlement of foreign currency. That way naturally all the foreign currency like U.S. dollars would remain among the people and convert the national wealth to personal wealth. If an enterprise or individual keeps all the foreign currency from international trade, and is not converting it to RMB, there won’t be a second time exchange problem equivalent to printing money,” he says.

Read the original Chinese article.