This why china has used its dollar reserves to enable

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Unformatted text preview: ountries to replace their foreign reserves with the Yuan must be based on China’s real resources. This why China has used its dollar reserves to enable its state-owned companies acquire overseas investments particularly in ‘natural and energy resources’. Further, China has signed deals with Russia, Brazil and Ecuador to secure long term oil supply by lending them dollar reserves. It has also spent dollar reserves to increase its Strategic Petroleum Reserves, and gold other precious metal reserves. Financial Position: After achieving the net creditor position in 1919, the US started exporting to the world through ‘dollar diplomacy’. This led to the swelling of dollar’s share in world reserves. In case of China, although it has positive net assets, it remains a capitalpoor country, and its FDI far exceeds its investments abroad. The Yuan can be acquired by the world in two ways: China invests in overseas assets or it purchases foreign commodities. Either way, it will take long to export significant amount of Yuan to the world. China’s International Investment Position In 100 million Net Position A. Assets 1. Direct Investments Abroad 2. Portfolio Investment 3. Other Investment 4. Reserves Assets B. Liabilities 1. Foreign Direct Investments 2. Portfolio Investment 3. Other Investment 2004 2,764 9,291 527 920 1,658 6,186 6,527 3,690 566 2,271 2005 4,077 12,233 645 1,167 2,164 8,257 8,156 4,715 766 2,675 2006 6,402 16,905 906 2,652 2,539 10,808 10,503 6,144 1,207 3,152 2007 11,881 24,162 1,160 2,846 4,683 15,473 12,281 7,037 1,466 3,778 2008 14,938 29,567 1,857 2,525 5,523 19,662 14,629 9,155 1,677 3,796 2009 18,219 34,601 2,296 2,428 5,365 24,513 16,381 9,974 1,900 4,508 S ource: SAFE, China Financial Institutions: Compared to Fed’s position in 1924, the People’s Bank of China has abundant experience as a central bank. With respect to the capital market, unlike US’s direct financing method, China’s indirect financing method offers reduced mobility for the Yuan and Yuan-denominated bonds. This is the reason why Japan failed to internationalize Yen. Further, China heavily regulates its financial system, particularly with respect to the restrictions on capital account and Yuan convertibility. However, things could change and the Yuan can become an attractive currency if China implements its intent to make the Yuan fully convertible, and the interest rate and exchange rate more flexible. Actions Support of the Existing Major Reserve Currency: In the 1920s, in order to inherit a strong financial system and avoid losses in the pound reserves, Fed reduced its discount rate twice to support the pound. In the past, China has supported the dollar by acquiring the US treasuries. Today’s dollar reserves far exceed the stock of pounds in the 1920’s. A bulk of these reserves is held by China itself. So, in order to inherit a sound system, China has to make sure that there is minimal erosion in dollar’s value. Dilemma: For the US...
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This document was uploaded on 01/14/2014.

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