China's ambitious plans for its huge reserves
Is it possible to have too much of a good thing?
I ask, because while so many Western governments spend sleepless nights worrying about the size of their trade deficits, China has the opposite problem.
Thanks to its export success, China is the world's largest holder of foreign exchange reserves. Those reserves are growing all the time and currently stand at a record $3.44 trillion.
That's $3,440,000,000,000 if you want all the zeros, or basically the size of the entire German economy.
What's in the reserves is a state secret, but a report in the China Securities Journal a few years ago revealed that 65% was held in dollars, 26% in euros, 5% in pounds and 3% in yen.
The Chinese are the largest holder of US government debt after the US central bank, the Federal Reserve. They also own European government debt, but perhaps not as many bonds from those troubled countries on the periphery as the eurozone governments would like to see.
During the height of the euro crisis the single currency would rise with every indication, sign, hint or vague rumour that China was planning to buy euro area bonds.
You might think that a trade surplus the size of China's would be good news. But according to People's Bank of China officials such as Deputy Governor Yi Gang, it's actually posing problems because of the fixed exchange rate.
Holding reserves is a way to protect a country's currency from attack, as selling reserves can help sustain the value of a currency. It's a lesson that central banks learned after the Asian financial crisis.
For China, the yuan floats within a narrow band of 1% on either side of a peg, so reserves are helpful. But it's unclear how much a country really needs.
It's not just a worry that the US dollar or euro will depreciate. The concern is also due to reserves contributing too much cash in the economy. That's leading to price rises, including in housing.
When a central bank accumulates reserves, it prints cash (yuan) to buy the dollars, euros, pounds and yen that it adds to its reserves. To prevent that cash from generating inflation (imagine if China added $3.4tn of cash to its $8tn economy), the central bank "sterilises" its actions by withdrawing the equivalent amount of cash from the economy.
It does this by paying interest on money that commercial banks deposit back at the central bank, so encouraging them to leave their cash there.
Sterilisation tends to be incomplete, as banks may want to earn a better return elsewhere instead of parking money at the central bank.
China does it better than most since it has a largely state-owned banking system which tends to do what it's told. Nevertheless, the reserves are still a source of excess money or liquidity.
What China wants
Compounding the problem is the worry that the central bank may not be earning a great return on those reserves, as the yields (or interest rates) on US and European government bonds are low.
So, instead, China is using its reserves to finance overseas investment. China wants to buy real assets - like ports, utilities, natural resources, technology and financial companies.
This has two benefits for the Chinese.
As well as the hope that real companies will earn better returns than financial instruments, it also helps them to achieve a larger economic goal - to build Chinese multinational companies.
China's 'going out' policy
Globally competitive firms could help China raise its technological capacity and productivity. That is key to sustaining economic growth. China would like to follow the example of other countries that have become rich - like South Korea or Taiwan - and develop successful global brands like Samsung and HTC.
This was China's aim when it launched the "going global" or "going out" policy in 2000. The first ever commercial overseas investment was in 2003-04 in Europe when the Chinese firm TCL bought France's Thomson brand. Since then, outward foreign direct investment has grown exponentially and reached record levels.
Last December was also the first time in which monthly data showed the amount invested overseas exceeded inward investment. That switch is typically an indicator of a country reaching a level of economic development.
State-owned enterprises have invested overseas for more than three decades and will continue to do so. China's state-owned firm, State Grid, the world's largest utility company, has just announced a second foray into Australia's energy market.
But the outward investment is diverse. It isn't just resources and energy. The largest regions for investment are other parts of Asia, followed by Latin America and then Europe.
Chinese firms have to receive permission to invest overseas, as the country still controls capital movements. Thus, Chinese investments are driven by what can almost be described as "competitive disadvantage". That is, they invest where the Chinese economy needs bolstering.
So, it's not just resources but also technology and higher valued services - which is why the countries receiving the most investment (excepting places like Hong Kong or the Cayman Islands) are Australia, Singapore and the United States.
However, Chinese investment is not always popular in the countries receiving it. State-financed investment can generate a political backlash, as has been seen in Australia and the United States.
Plus, private Chinese firms can find it challenging to operate due to a lack of transparency as to what is state and what is private. This suggests an important area of reform for China, which is to make it clearer the sources of financing for its overseas deals and the ownership of Chinese companies.
Problem solves itself
Chances are, China won't be running the large trade surpluses of the past.
Last year, the surplus fell to less than 3% of GDP from the over 10% reached before the 2008 global financial crisis. They won't sell as much to overseas markets as those economies slowly recover, so China is unlikely to accumulate reserves to the same extent as before.
It also means that it will be more important for Chinese overseas investment to be accepted since China will rely more on having productive and competitive multinational firms to grow. And those firms may increasingly need to raise financing on a more competitive basis.
What is clear that we will see Chinese companies increasingly on the global stage. Their success will matter not only for the companies, but also for the country's continuing growth.