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China's Catch-22: $2-trillion in foreign reserves

The People's Bank of China in Beijing


How do you spend $2-trillion (U.S.)? Very slowly.

China's massive foreign currency reserves place it in an enviable position compared with other debt-ridden, import-dependent economies. But China's economy has slowed, it is worried about a depreciating U.S. dollar, and its trading partners are irritated that the country is keeping its own currency, the yuan, undervalued. So China is starting to move its $2-trillion in currency reserve savings - of which around two-thirds are denominated in U.S. dollars - into the real economy.

That's easier said than done. And it's not always in China's interests to do so.

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China Investment Corp.'s (CIC) purchase of a 17.2-per-cent stake in Teck Resources Ltd. for $1.74-billion (Canadian) is just one in a series of recent investments by Chinese-run companies in foreign commodity producers. The deal comes just a week after Sinopec, China's largest oil refiner, agreed to buy Toronto-listed Addax Petroleum Corp. for $7.24-billion.

CIC manages only about one-10th of China's foreign assets. The biggest player is the People's Bank of China, the country's central bank.

China's holdings are so large - the next largest holder of foreign currency reserves, Japan, has around $1-trillion (U.S.) - that any moves it makes will have an impact on global markets. That's why, as much as it may want to diversify, it can't afford to do it quickly.

"It's a sort of financial Catch-22. They want to sell their U.S. dollars, but doing so reduces its value," said Randall Morck of the University of Alberta.

Zhou Xiaochuan, head of China's central bank, wrote last week that the country is looking for a new global "reserve" currency that is more stable in the long term than the U.S. dollar. That would increase the bank's confidence that it can start safely shedding some of its foreign reserve holdings like U.S. Treasury bills with minuscule yields.

"There is an increasing suggestion from the government and Chinese think tanks to diversify [reserves]into equity investments. They want safety, but they also want a reasonable rate of return," said Kenny Zhang of the Asia-Pacific Foundation, a think tank based in Vancouver.It's hard for the central bank to invest directly in companies. It can increase Chinese investment abroad and decrease reserves by facilitating lending to its major commercial banks and cutting interest rates.

There's also a way to unlock money by spending it at home. The Chinese savings rate has been very high of late - standing at 54.4 per cent of gross domestic product in 2006. The government has introduced a $586-billion stimulus package to spur the domestic economy. This inward focus can increase the appetite for foreign acquisitions.

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"The Chinese are concerned about the future availability of various minerals and oil for their economy. They are attempting to lock in secure supplies by buying stakes in resource companies everywhere," Prof. Morck said.

The country is diversifying, but slowly. The U.S. government reported in April that despite a record trade surplus for China of $114.3-billion in the fourth quarter of last year, China's foreign reserves grew by only $40.4-billion - suggesting that it was deploying some of its excess reserves abroad.

But it would take a lot of $1.7-billion deals, even if that's large to recipients like Teck, to make a major dent in China's stash of greenbacks.

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