You Are Now Supposed to Worry About China Because Its Reserves Are ‘Just’ $2.99 Trillion

China’s foreign exchange reserves dipped to just under three trillion dollars last month. Yes, $3,000,000,000,000.

That is more than the entire annual GDP of all but the world’s top 4 economies. It is also the largest pile of foreign currencies held by any nation by far.

Nonetheless, three years ago China owned $4,000,000,000,000 in foreign-denominated assets. Thus we are told the 25% decrease is actually a very significant event signaling all sorts of gloom. Quartz:

How times have changed. In January, China’s foreign-exchange reserves slipped to their lowest point in six years. Chinese investors, anticipating better returns in foreign assets, want to get their money out of the country. And the government is drawing down its reserves like crazy to try to keep those outflows from tanking the yuan.

The New York Times:

More broadly, the dwindling reserves say something about the direction of the Chinese economy. It shows that the era when the world rushed to invest in China to build factories or apartment buildings — generally, to get a piece of the action — is fading.

OK fair enough. Suppose there was a company which had previously saved 4 billion in capital but was now bleeding money to the point it now only had 3 billion left that would have probably signaled business was rather poor.

That is supposedly the case with China. In a cascade of events a less optimistic vibe in China is encouraging capital outflows which are threatening the value of yuan. Forcing the government to spend almost one trillion dollars in defense of the yuan so far.

Floating the currency would stop the bleeding of foreign reserves, but would also mean the yuan would crash from its inflated value vis-a-vis the dollar. Except this widely accepted (apparently even in China) narrative just doesn’t stack up with the fundamentals.

Every month China racks up around $50 billion in trade surpluses. It is not actually bleeding dollars. It merely choses to divest itself of more of them than it earns — buying yuan in return.

This is supposedly a rotten deal since yuan is allegedly overvalued and destined to fall, but is it really so? As we said China is more than able to pay for its imports with exports.

US on the other hand runs up a trade deficit of $40 billion every month. It is not able to pay for its imports except by issuing ever more dollar-denominated IOUs. In other words US is forced to bring ever more dollars into existence just to cover running expenses.

So then why exactly is dollar the stronger currency of the two? Obviously enough, fundamentals favor the yuan.

Sure enough, in the short term markets can do a lot of stupid things. Large crowds can work themselves into bizarre moods in finances as well as on the streets. But in the long term reality has to smash them in the head.

Capital can rush for the exit door but where exactly is it going to go? The US growing at 1.9 percent GDP? EU growing at 0.5 percent? Japan growing at 0.35 percent??

In fact by obstructing capital outflow Chinese government is only delaying the day when fleeing money realizes the mistake it is making (talk of higher rates in the US is just that, talk). However, at least in the mean time China gets to trade in overvalued dollars at their still overvalued price.

Let’s recall that China’s worries began in 2008 when crisis hit US and Europe. It is US and EU which have a fundamental problem. China’s setback was merely in that its main customers were suddenly a lot poorer. But then in China’s case the solution is starting it in the face.

Instead of blowing money on wasteful government stimuli (which exert a tremendous downward pressure on its currency), as done so far, all China has to do is let its currency float — and therefore sooner or later greatly appreciate. This would automatically increase the purchasing power wielded by China’s own population — at which point Chinese manufacturers can go from selling goods to foreigners who can not really pay for them except with IOUs, to selling them to the now significantly wealthier citizens at home.

I’m sorry but it’s not the people with the factories who have the real problem here. It is the people who have to print bonds just to pay for their manufactured goods who are really in a pickle.