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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
1. Direct Investments Abroad
2. Portfolio Investment
3. Other Investment
4. Reserves Assets
1. Foreign Direct Investments
2. Portfolio Investment
3. Other Investment 2004
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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- Winter '14