I recently sat in during a presentation of a head economist of a BB and he was confident that China will be, in the next 5 or so years, the next dominant economic superpower. When questioned on that view he made light of the fact that China can basically not fail with their US$2-3 trillion or so in reserves. Everyone seems to make this argument except, it seems, Michael Pettis.
He writes (http://seekingalpha.com/article/189875-china-what…, http://tomjconley.blogspot.com/2010/02/michael-pe…):
This is why I have often said, to the confusion of some of my readers, that Beijing cannot just recapitalize the banks with reserves. A substantial amount of NPLs will one way or another increase government debt. The only way Beijing can recapitalize the banks is by borrowing, or by raising direct (or hidden) taxes. Having the PBoC recapitalize the banks is just another way for the government to borrow, and since almost everyone would agree that losses in the banking system should be paid directly out of fiscal revenues, and not indirectly by the central bank, it would be a very inefficient way of doing so.So what are reserves good for? As long as China maintains its own currency and denominates all domestic transactions in RMB, the PBoC reserves cannot be used in China. They cannot go to pay doctors’ salaries, to build bridges, to lower taxes or to subsidize consumption. They can only be used to purchase or pay for things from outside China. This means that reserves ensure that China can import foreign commodities and other goods as long as it can pay for them domestically. It also means that the PBoC can ensure the availability of dollars to repay foreign debt and foreign investment The idea that massive levels of reserves are a guarantor of economic stability is, in other words, based on a profound misunderstanding both of history and of the nature of reserves. Reserves of course are not useless as an enhancer of financial stability, but their use is for very specific forms of instability. Having large amounts of reserves relative to external claims protects countries from external debt crises and from currency crises.
Why aren't these arguments brought up more in the media? Is there something fundamentally wrong with his thoughts?
Why is it not discussed? Because it's wrong. Here's why: http://www.wallstreetoasis.com/blog/china-to-downgrade-us-debt
Why is it wrong? Another SeekingAlpha regular voiced the same opinion as Pettis: http://seekingalpha.com/article/196123-three-reasons-analysts-have-rose… .
Clearly, the theory isn't verified just because two people are in agreement but I'm interested in finding out why you feel their view is flawed.
bump
doesn't china just print rmb anyway to buy up dollars? wouldn't they just print rmb to recapitalize banks if it became necessary?
This is how I understand it: China can print RMB to cover domestic expenditures (including recapitalizations). This would increase RMB supply and the currency would depreciate relative to all other currencies. The PBOC can then buy RMB with their trillion$$ of reserves and prop up the currency again.
Two things to note however: 1. By selling so many dollars China will most likely decrease the value of the USD which would effectively cause losses on their FX reserves 2. A weaker RMB promotes Chinese exports, so they keep it artificially low by buying USDs and selling the RMB
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