Ape Man

China’s behavior has just been insane over the last couple of months. There is simply no other word for their actions. They are engaging in activities that are so bizarre that I can barely believe that the people running China’s economic policy have enough intelligence to cause their hearts to beat. From Brad Setser’s Blog….

There is just no way to get around the fact that China bought a ton of foreign exchange in the first quarter. Its reserves went up $135b in the quarter – topping its previous record quarter ($85 or so in q4 04). Only about $5b of the increase came from valuation gains v. $20b or so in late 2004, so China actually bought a lot more fx in the market now than then — $130b v $75b (by my estimates). $130b in a quarter works out to $520b for a year.

He goes on to say….

Roughly $100b of China’s $130b in reserve growth probably flowed into dollar assets. That roughly what it would take to keep the dollar share of China’s reserves constant.

If it keeps going at that rate, China will have increased its reserves by 400 billion dollars this year. To put that in perspective, that is only slightly smaller than the entire cost of the Iraq war to date. And that money was spread out over years; China is on track to increase its reserves by about that much in one year alone.

As Brad Setser says…

I never expected China would be on track to add $500b to its reserves in a year, or the world a trillion. Never. Back in 2004, I though the world’s central banks wouldn’t sustain a $600-700b pace of increase. The numbers are so large that in some sense they are hard to believe. But I have double and tripled checked the numbers. They are in the data. The COFER data (especially if you add in SAMA’s non-reserve foreign assets). The IMF WEO data. The national data when the big central banks are added up. This is real.

The really sick thing about this is that even the Chinese admit that their dollar reserves are already too large. They must be really scared of a devaluation dollar. But this is simply bizarre. They are growing their reserves far faster than their economy is growing. Mathematically, there is no way that they can keep this up. By piling on their reserves at this rate, they are only increasing their future losses.

The numbers and how crazy they are is dealt with very ably by Brad Setser and Macro Man. But I want to add a point of my own to the mix.

First let me point out that Setser has shown that the current account imbalance in the US has been increasingly funded by foreign government entities. If things continue at their current rate, foreign government entities will provided almost a trillion dollars in financing to the US (with the Chinese providing almost half that figure all by themselves).

Now if you follow economic commentary to any degree, you will find that the more devoted an economist or other economic commentator is to free markets, the more likely they are to argue that we should not be worried about the current account balance. In spite of being pretty close to being a free market purist myself, I have long felt that such arguments were irrational.

How can one claim that the free market is the best way of setting prices and then turn around and say that the fact that foreign governments are on track to paying out almost a trillion dollars to manipulate the US currency is no big deal?

This entry was posted on Friday, April 13th, 2007 at 8:21 pm and is filed under Economics. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.