could china use its trade surplus ???

China is in the historically unusual position of being an immature

creditor: its own currency, the renminbi, is hardly used at

all in financing its huge trade (saving) surplus. Instead, the

world—particularly the Asian part of it—is still on a dollar

standard. The dollar is the invoice currency of choice for most

Chinese exports and imports and for open-market, that is,

nongovernment, controlled financial flows. So we have the

anomaly that the world’s largest creditor country cannot use

its own currency to finance foreign investments.

The lag in the international use of the renminbi is partly

because China’s domestic financial markets are not fully

developed. Interest rate restrictions as well as residual capital

controls on foreign exchange flows remain. But a more

fundamental constraint is that the U.S. dollar has the firstmover

advantage of being ensconced as “international

money.” World financial markets shun the use of more than

one or two national currencies for clearing international payments—

with the euro now in second place. But the euro’s

use in payments clearing is still pretty well confined to

Europe’s own backyard (Eastern Europe and former

European colonies). Thus, dollar dominance makes the internationalization

of the renminbi very difficult—although the

People’s Bank of China is trying hard to encourage the renminbi’s

use in international transacting on China’s immediate

borders.

The upshot is that China’s own currency is still not used

much in lending to foreigners. Foreigners won’t borrow from

Chinese banks in renminbi or issue renminbi- denominated

bonds in Shanghai. But, apart from direct investments abroad

by Chinese corporations, private finance for China’s trade

surplus would have to take the form of Chinese banks, insurance

companies, pension funds, and so on, acquiring liquid

foreign exchange assets—largely in dollars. But their domes

tic liabilities—bank deposits, annuity or pension liabilities—

are all denominated in renminbi. Because of this currency

mismatch, the exchange rate risks for China’s private

banks and other financial institutions are simply too great

for them to be international financial intermediaries, that is,

to lend to foreigners on a large scale.

China’s current large trade (saving) surpluses, which

run at about $200 billion to $300 billion per year, would

quickly cumulate to become much greater than the combined

net worth of all of China’s private financial institutions.

Because these private (nonstate) institutions would

refuse to accept the exchange risk (possible dollar depreciation)

of holding dollar assets on a significant scale, the

international intermediation of China’s saving surplus is

left to the central government. The problem is worsened by

American “China bashing” to appreciate the renminbi, the

expectation of which makes foreigners even

more loathe to borrow in renminbi—while stimulating

perverse inflows of hot money to China.

The upshot is that China’s central government

steps in to intermediate and control the

country’s saving surplus in several different

ways.

First, huge liquid official reserves of foreign

exchange, currently about $2.5 trillion, are

accumulated in the State Administration of

Foreign Exchange. Next, sovereign wealth funds

are created, like the China Investment

Corporation, which invests overseas in bonds,

equities, or real estate. Third, China’s large stateowned

enterprises such as SINOPEC are

encouraged to invest in, or partner with, foreign

oil companies in exploration and production.

And finally, quasi-barter aid programs in developing

countries generate a return flow of industrial

materials.

Regarding this last, China does not give

“aid” to African or Latin American countries in

the conventional form of liquid dollar deposits.

Instead, China’s overseas investments are combined

with aid under the fairly strict government

control of China’s Export-Import Bank or

the Department of Commerce. In return for

using state-owned construction companies to

build large-scale infrastructure for ports, railways,

power plants, and so on, the recipient

country agrees to repay China by giving it a

claim on a future stream of copper or iron ore or

oil or whatever mineral that the infrastructure

investments make possible, whence the “quasibarter”

nature of the deal. Because these foreign

aid/investment projects are under the

control of state-owned financial intermediaries, they

become effectively illiquid. They will not be suddenly

sold off and become part of hot money flows back into

China.