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China to "Invest" Reserves

February 6, 2007

Tags Financial MarketsGlobal Economy

An Asia Times piece by Zhou Jiangong earlier this week describes a complicated plan by the Chinese Ministry of Finance to in essence reallocate a portion of its portfolio of US Treasuries and agency debt into other asset classes. This news continues a trend on the part of central banks holding large reserves to allocate an increasing portion of those reserves to private capital markets.

According to the Asia Times, a new so-called company, in reality a state-owned central planning agency, called the National Foreign Exchange Investment Company. The company will be intiially funded through a complex transaction shifting assets from the Ministry of Finance, the current holder of China's forex reservers, to the new company. The size of the initial funding pool will be about 1.6 trillion yuan, equivalent to $200 billion. The new agency will allocate its assets to private sector capital markets, according to the Asia Times:

The new company, tentatively named National Foreign Exchange Investment Company, will be controlled by the State Council, China's cabinet. It will spend funds from the foreign reserves on mergers and acquisitions of overseas businesses, including foreign financial institutions. It will also target overseas energy assets and will likely acquire equities in the domestic markets, or even lend money to help finance domestic research and development projects.

I don't have a lot to say about this development that I have not already said about previous ventures of central banks into private capital markets. (I have written on this article before for for Mises.org on the topic Will Central Bankers Become Central Planners? and two other entries on this blog, one on Korea and one on reserves generally. See also Nouriel Roubini's recent piece on currency pegs.)

What is noteworthy about this announcement is that the move by China out of US Treasuries appears to be underway. This move has been predicted by a number of analysts who have pointed out that the central bank of China is exposed to potentially large losses if the US$ exchange rate were allowed to float to the market value against the Yuan. This plan suffers from all of the same problems of similar plans. Primarily, there is the economic calculation problem: central planners cannot allocate private capital effectively. The politicization of investment is another likely problem. And lastly, while the magnitude of the funds is not particularly large compared to world capital markets, it is a large amount relative to the size of the Chinese banking system, a point touched on in the by the Asia Times.

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