China´s melting foreign reserves – Victor Shih

China has been throwing much foreign reserve to maintain the value of its currency, the yuan. Financial analyst Victor Shih says in Bloomberg that while there is no acute problem, not all is well after hundreds of billions have evaporated.

Bloomberg:

The Communist leadership’s pledge to give markets a bigger say in the economy is running up against the reality that currencies can be prone to overshooting, as seen in the large appreciation in the yen during the 2007-2009 global crisis. Refusing to let the yuan, or renminbi, settle on its own means increasing scrutiny of the usability of China’s $3.4 trillion of reserves.

“When the PBOC talks about an orderly depreciation, there’s no free lunch — it has a cost,” said Victor Shih, a professor at the University of California at San Diego who studies China’s politics and finance. “The PBOC would need to spend down its foreign exchange reserves in order to manage the spot rate.”

China doesn’t provide a breakdown of its reserves, and some of the assets could be in illiquid investments or already committed to fund other government projects. The U.S. measure of China’s holdings of Treasuries, the benchmark liquid investment in dollars, stood at $1.25 trillion in October — though Chinese investments are in part channeled through other countries. Chinese companies and banks have billions worth of foreign currency borrowing, a liability to be considered against the nation’s reserves.

Altogether, China’s usable reserves are hundreds of billions less than the headline suggests, according to Shih. The latest official estimate of the total is scheduled for release Thursday.

“We should be skeptical of the $3.4 trillion,” he said. “It doesn’t make China a basket-case, but it’s certainly lot less safe than most people would assume.”