Chinas Foreign Exchange Reserves

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Chinas Foreign Exchange ReservesMyths of the
Current Financial Crisis
Presented by your friendly classmate Tristan
ZHUO (pronounced draw)

• On the first day of April, 2009
• a.k.a. April Fools Day

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What is Foreign Exchange Reserves (Forex
reserves)?

• Foreign exchange and gold, SDRs (Special Drawing
  Rights) and IMF reserve positions
• Assets of the central bank held in different
  reserve currencies, mostly the U.S. dollar, the
  Euro and Yen
• Used to back its liabilities

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Chinas Forex Reserves

• Two trillion dollars. 2,000,000,000,000
• Larger than the G7 combined Canada, U.S., U.K.,
  France, Italy, Japan, and Germany.
• How much is 2 trillion bucks?
• Larger than the annual GDP of the following
  countries Russia, Spain, Brazil, Canada, and
  Australia
• 17 times the combined net worth of Warren Buffet
  and Bill Gates
• Dramatic increase was at only 1 trillion as
  recently as October, 2006.

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Composition of Chinas Forex Reserves

• Remains a secret
• An educated guess 70 in U.S. dollars, 20 in
  Euros, and 10 in Japanese Yen
• Of U.S. dollar denominated assets, about 70 in
  treasury bonds and the rest in agency debts (such
  as Fannie Mae and Freddie Mac)

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The Diversification Problem

• The sheer amount of reserves makes
  diversification a problematic issue (any
  diversification move will significantly affect
  market value)
• Chinas reserves are enough to
• buy nearly half of the worlds gold
• buy all the properties in London
• Any major move away from U.S. dollar assets will
  erode the value of forex reserves.
• Bottom line Damned if you diversify, damned if
  you dont.

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Sovereign Wealth Fund

• state-owned investment fund
• China Investment Corporation was founded on
  2007.09.28 US200 billion assets.
• Performance so far D-I-S-A-S-T-R-O-U-S
• Spent 3 billion on 9.4 of Blackstone. Purchase
  price 30 Most recent price 7.9
• Spent 5 billion on 9.9 of Morgan Stanley.
  Purchase price 53 Most recent price 24.35

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How to spend the money?

• Domestic stimulus package
• Spread the wealth (hands out US1,500 for every
  Chinese citizen)
• Buy foreign assets (adverse selection problem due
  to political pressure). Only companies in trouble
  are likely to be allowed to sell stakes to the
  Chinese.

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The currency conversion problem

• Spending the money on domestic projects will not
  reduce the amount of forex reserve
• Two possible (but not probable) solutions
• Quasi-dollarization (along with the Yuan, the
  U.S. dollar becomes one of two legal tenders in
  China)
• A flexible exchange rate regime

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Benefits of a flexible exchange rate

• An exchange rate that is determined by market
  supply and demand and thus sends out clear
  signals to market participants
• Not subject to the whims of politicians
• Eliminates the one-way currency bet and the
  inflow of hot money
• Eliminates the need to monitor and manage lots of
  inflows
• Reduces inflationary pressure
• Acts as an automatic stabilizer amid external
  shocks

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Myth of the financial crisis

• Free market does not work well unless governments
  regulate it, as evidenced by the current turmoil.
  
• Implications of this position
• Bigger government
• Smaller private sector
• More ham-fisted (not smarter) regulations
• Before Americas business is business.
• After All businesses are Washingtons business.

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What really caused this crisis?

• Most Americans treat their houses as an ATM
  instead of a place to live in. Condo-flipping
  became a national sport.
• But blaming households doesnt win you any votes,
  so lets blame Wall Street and the free market.
• The Federal Reserve has been consistently sending
  out incorrect signals of risks via short-term
  interest rates announcements.
• Short-term rates are set by central bankers while
  long-term rates are set by the bond market. But
  most central bankers consider themselves above
  the market.
• Alan Greenspan The conundrum
• Ben Bernanke (helicopter Ben) Quantitative
  easing (printing money by another name)

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Is there such a thing as a free market?

• Labour market
• Minimum wages
• Punitive severance pay
• Bellicose unions
• Goods market
• Short term interest rates are the single most
  important price in the economy but are fixed by a
  20th century invention called the Central Bank.

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The beginning of the end of capitalism?

• Capitalism without failure is not capitalism.
• Successful companies used to be the ones that
  survived due to higher efficiency, innovation,
  and better operations.
• Not any more! Every firm is too big to fail. If
  youre struggling, well put you on life support
  and never let you die. If youre successful,
  well punish you by taxing you harder and use the
  proceeds to save the patients who may never
  recover.

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• Blaming free market for the current crisis
• Blaming Santa Claus for a bad Christmas present

Questions? Anyone?