Mystery of China’s huge US dollar pile baffles world markets

Unprecedented trade surpluses and record inflows into its bond market are giving China a dollar reserve unprecedented since the days when “excess Asian savings” were blamed for keeping US interest rates excessively low and fueling the crisis. subprime mortgages.

But unlike back then, when China aggressively recycled its dollar holdings in US Treasuries, China’s gigantic pile of foreign exchange reserves remains virtually stable. That means the dollars are being funneled elsewhere, but exactly where is turning out to be a bit of a mystery.

While some of that flood of greenbacks is ending up as deposits in Chinese banks, big “errors and omissions” in the nation’s balance of payments are clouding the picture. What is clear is that dollars offer China an important cushion against any future shocks to the world economy, even as individual companies like China Evergrande struggle to pay off their debts.

“It’s extremely difficult to get a clear picture of how China’s current account surplus is being recycled,” said Alvin Tan, head of foreign exchange strategy for Asia at RBC Capital Markets in Hong Kong. However, the dollars mean that “whatever China’s economic challenges lie ahead, there is little danger of a balance of payments or external debt problem.”

Bank deposits in foreign currency are just shy of a record $ 1 trillion ($ 1.4 trillion), while the trade surplus in the first nine months of this year reached around $ 440 billion in comparison. with the 2015-2019 average of $ 336 billion and 2020 $ 325 billion, according to Morgan Stanley estimates.

At the same time, an aggressive COVID-zero policy has closed the nation’s borders and kept millions of Chinese tourists and their savings at home.

Some analysts argue that the current account boom has allowed China’s policymakers to control massive amounts of debt and begin a long-awaited campaign to deleverage its troubled real estate sector this year. But that leaves the question of whether US demand for goods will maintain enough momentum to offset the effects of China’s slower credit growth.

“Chinese macroeconomic policy has become a big gamble for America’s growth as it tried to replace its credit drive through the current account,” JST Advisors’ Jon Turek wrote in recent research. “China restricted credit while the external account surplus exploded. This allowed China to import the aggregate demand that it was ‘sacrificing’ to reduce credit growth. ”

The State Administration of Foreign Exchange released the balance of payments data for the third quarter on Friday. They suggested “the fastest build-up of reserves since early 2014,” the Goldman Sachs analysts wrote. That is an outlet for excess dollars, although official reserves as of September were lower than at the beginning of the year.

Economists forecast that China will post another trade surplus when it releases the October data on Sunday, this time to the tune of about $ 64 billion.

China’s current account, a measure of trade and investment, fell into negative territory in the first quarter of 2018 for the first time since it joined the WTO in 2001, raising questions about what that meant for the flow of trade. capital around the world. It plunged into the red again in the first quarter of last year, when coronavirus restrictions shut down factories but has since rebounded as China’s export engines revved to full throttle again.

One consequence of the influx of dollars is the continued strength of the yuan: it has been the best performing currency in Asia this year against the dollar. But that is not enough to explain what is happening to all those greenbacks.

One possibility is that the companies have left a large chunk of their foreign trade revenue abroad, said Becky Liu, head of China macro strategy at Standard Chartered.

“This means that the increase in foreign currency holdings is in the hands of the private sector, rather than the public sector,” she said.

The retention of growing foreign currency assets by Chinese private sector entities, rather than flowing to the public sector, will help reduce market volatility and prepare China for further opening of its capital account, he said. she.

Huang Yiping, a former member of the monetary policy committee of the People’s Bank of China, said in an interview with Bloomberg Television that the current account surplus will likely recede from these high levels as exports weaken over time.

“This large current account surplus I think is abnormal,” he said. “Once the pandemic is over, we should expect some normalization of these numbers.”

Yet for now, at least, the dollars keep coming.

Goldman Sachs estimated net inflows of about $ 14 billion for September, well above the $ 5.5 billion recorded in August, driven by both the goods trade surplus and foreign purchases of Chinese bonds.

Analysis by Stephen Jen, who runs Eurizon SLJ Capital, a hedge fund and advisory firm in London, shows that China’s trade surplus execution rate is approaching $ 600 billion a year, which if sustained would become the second-highest. The balance of payments is so level from a record in 2007, he notes.

Other theories about where dollars are recycled include Chinese companies investing abroad or using the cash to fund projects like those linked to the Belt and Road Initiative.

“The pandemic has created huge distortions in the world, one of which is an extremely large trade surplus in China,” Jen wrote in a note. “Long-COVID should mean that such a flattering trade surplus should take time to disappear.”

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