| Foreign exchange reserve is a kind of foreign asset which can be held by the monetary authorities to settle import, repay short-term debt, stable exchange rate and maintain market confidence. It is the most important part of China's international reserve system.China used to be disturbed by lack of foreign exchange long ago. But since 2001, China's foreign exchange reserve has grown dramatically. By the end of the February of 2006, China had exceeded Japan to be the world's largest foreign exchange reserve holder. China's foreign exchange reserve broke through one trillion U.S. dollars in October, 2006.The Sino-U.S. economic imbalance is the direct cause of the excessive growth of China's foreign exchange reserve. The Sino-U.S. economic imbalance is the essential part of global economic imbalance. On one hand, since 1994, there has been an ever growing huge amount of"double favorable balances"(from current accounts and capital accounts) which promotes the excessive growth of China's foreign exchange reserve; on the other, at the same period, there has been an ever growing huge amount of"double deficits"(from current accounts and treasury ) in the U.S..According to the traditional theory, trade imbalance between two countries could be automatically adjusted to return to balance. However, the imbalance of international payments between China and the U.S. has been defying traditional theory to keep expanding, that will enlarge the Sino-U.S. economic imbalance.The reason for untraditional expansion of the Sino-U.S. economic imbalance is that there are two circulatory mechanisms of international capital between China and the U.S.: the debt-asset cycle and the liquidity cycle. Thus the excessive growth of China's foreign exchange reserve is the essential link of the two mechanisms.In the debt-asset cycle, China's foreign exchange reserve is an asset derived from debt. Since the reform began, China has been attracting a great amount of foreign direct investment (FDI) and developing manufacturing trade to grow a huge amount of"double favorable balances", thus China's foreign exchange reserve enlarged. Since FDI is a kind of debt to China, China's foreign exchange reserve is an asset derived from debt.To the U.S., FDI is also an asset derived from debt. A great amount of China's foreign exchange reserve would be invested in the U.S. bond market to make it cheaper for the U.S. companies, especially the U.S. multinationals to finance.The liquidity cycle is connected with the revived Bretton Woods System in which both the"Triffen Dilemma"and the"N-1"problem exist. However, China could absorb liquidity surplus within the mechanism.The investment-saving imbalance (the IS imbalance) between China and the U.S. is the root of the excessive growth of China's foreign exchange reserve.On one hand, the consumption of the U.S. is very active within the credit system because of highly developed financial system, while saving rate is getting lower and lower. On the other hand, China's saving rate is getting higher and higher while its consumption rate is much lower than that of the U.S..The primary reason for the growth of China's national saving rate is the rapid growth of the governmental saving rate. This ,combined with the growth of China's entrepreneurial saving rate,has made it hard for the expansion of residential consumption.The excessive growth of China's foreign exchange reserve has much induced liquidity surplus into China and made RMB dual: appreciation abroad and depreciation at home. In order to contain the imbalance ,the Chinese monetary authorities employed tightening of monetary policy time and time again, but soon found itself within the conflict between monetary policy and exchange policy.China should make policy coordination with its Asian neighborhood and carry forward reforms on economic structure to improve the IS imbalance. China also has to reform its foreign exchange management to contain the size of the asset. |
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