The Study On The Capitalization Of Chinese Foreign Reserves

The evolution of huge foreign reserves accumulation in China has undergone the stage of stock shortage during the period from its foundation to the early time of its reform and opening up to the outside world, that of increasing growth in 1980s and 1990s, as well as that of expansion at full speed in the last decade in 2000s. By the first half of 2011, Chinese foreign reserves has been close to 3200 billion U.S. dollars, which accounts for more than 50 percent of Chinese gross domestic product valued at over 6000 billion U.S. dollars. China has been the largest holder of foreign reserves in the world during the last 5 years. On the one hand, the huge amount of foreign reserves provides China with important wealth guarantee for guarding against and dissolving international financial risks, realizing payments balance, enhancing the flexibility of RMB exchange rate, and upgrading China's international standing. On the other hand, it has been continuously increasing at 30.85% per annum on average since 2000s, which exacerbates the risks arising from the management of its size and investment, and brings about greater challenges on its investment portfolio arrangement as well as value-ensured and value-added objectives. The issue of Chinese foreign reserves has been an open debate of Chinese monetary authorities and economic academics, but also a focus concerned by the international community, especially the debt crisis countries, such as the United States.In this context, the thesis explores the risk-return characteristics of the main modes of capitalization of Chinese foreign reserves on the guidance of the theories of money capitalization proposed by Marx and Keynes, and attempts to offer the policy suggestions for optimizing the value-ensured and value-added modes of Chinese foreign reserves.The first chapter illustrates the evolution and channels of Chinese foreign reserve accumulation. From one aspect, the evolution of Chinese foreign reserves accumulation from stock shortage to increasing growth and then to excessive expansion is a mirror of the increasing development path of Chinese national economic growth, foreign trade opening up to the outside world and international capital inflows into China. How to deal with such huge foreign reserve wealth is a"sweet trouble"to China. It not only brings in the arguments on the excessiveness of foreign reserves by Chinese academics and facilitates the gradual transformation from passive reserve management to active reserve management carried out by Chinese monetary authorities, but also results in resentments and dreads of the developed countries led by United States to China. The thesis posits that the excessiveness of Chinese foreign reserves is not the main concern because the capitalization of money inherently lasts infinitely. For China, the key issue is how to infinitely maintain and increase the value of foreign reserves by relying on the modes of investment of foreign reserve capitalization.The second chapter discusses the classical theories of money capitalization proposed by Marx and Keynes, and sums up the contemporary theories of capitalization of foreign reserves. The theory of money capitalization proposed by Marx is based on the view of the use value of money. According to it, foreign reserves of one country, being the distinctive money managed by monetary authorities, also has the capital attribute of money. The capitalization of foreign reserves is a process of enhancing the value of foreign reserves through their investments and usages. The theory of money capitalization proposed by Keynes is based on the view of trade surplus. According to it, only when there is a trade surplus or payments surplus, could the monetary authorities of one country accumulate foreign reserves. And only when the accumulated foreign reserves are used as capitals for making foreign investments, could the country generate more profits and further heighten its strength. The two economic masters happen to hold the same view leaping over the time and space. Their theories of money capitalization are theoretical forerunners of current studying of value-ensured and value-added issues of Chinese foreign reserves. The diversified investment of Chinese foreign reserves reflects the developed application of the theories of money capitalization proposed by Marx and Keynes in the operation of Chinese foreign reserves. At present, our country has established a diversified investment portfolio of foreign reserves according to Markowitz's investment portfolio theory, and the next step is how to optimize the portfolio. Therefore, the subsequent three chapters study the modes of foreign reserve investment.The third chapter studies the mode of Chinese foreign reserve investment in U.S securities. Through analysis, it points out that, in the medium run, the foremost channel and the supplementary channel of the capitalization of Chinese foreign reserves are still the investments in U.S. treasury bonds and agency bonds represented by those issued by Fannie Mae and Freddie Mac, respectively. As far as the investing country of foreign reserves China is concerned, the said channels bring about securities investment returns on foreign reserves. And as far as the financing country the United States is concerned, the said channels fully reflects China's huge contributions to American economic development via dollar consequently flowing back to it. As the largest creditor and importer to U.S., China provides it with not only a larger amount of foreign funds directly, but also a great quantities of commodities and resources, which makes American economy be able to consume on credit via overdraft and to develop by raising debt, American production and employment be stable, and American people enjoy good living standards many times as much as our people.The fourth chapter studies the mode of Chinese foreign reserve investment in sovereign wealth funds. In addition to the investment in U.S securities, the mode of investment via sovereign wealth funds should be the important new mode of capitalization of Chinese foreign reserves. The Chinese government should increase the foreign reserve injection proportion to them, and make them the main investment platform to invest foreign reserves in assets with more risks and high returns.The fifth chapter studies other modes of Chinese foreign reserve investment, such as the investments in gold and financial derivatives, the participation in regional cooperation, and the functions performed in both internal and external markets.Firstly, China should place emphasis on the protective advantages of gold, and treat the transformation of foreign reserves into gold reserves as an essential complementary channel of capitalization of Chinese foreign reserves. It should increase the foreign reserve investment proportion in gold to change the existing problem of"excess size but deficient proportion"in gold, and carry out a dual foreign reserve operation system characterized by official and non-official holdings of foreign reserves through innovating gold-foreign-reserve-linked products and taking policy measures to stimulate domestic residents to hold foreign reserves and trade gold with foreign reserves.Next, China should treat the foreign reserve investment in financial derivatives as an ordinary complementary channel of capitalization of Chinese foreign reserves. It should gradually deregulate the investment in financial derivatives and set investment benchmarks on the basis of the establishment of the domestic RMB-foreign exchange derivative market and the steps of gradual convertibility of our capital and financial account in order, so that the investment in financial derivatives can give play to the diversification and profitability of foreign reserves.Finally, China should use foreign reserves to actively participate in regional monetary cooperation, push forward the development of RMB from regionalization to internationalization, and to make itself a decisive leader in the operation of"Asian Regional Foreign Reserve Pool". It should allocate foreign reserves into the key domestic foreign trade and investment areas to directly support domestic physical economies to realize higher international transaction returns and to indirectly enhance the capitalization returns of foreign reserve investment. It should also bring international financing of foreign reserves into play. China's subscription for the treasury bonds issued by European sovereign debt crisis countries and the international financial bonds issued by International Monetary Fund to remedy the global financial crisis, all without exception, exhibits that China is a long-term responsible investor during the capitalization of its foreign reserves, an increasingly rising economic powerhouse during the process of facilitating regional and international economic development, and a reliable country with benevolence and kindheartedness during the process of remedying European and American sovereign debt crises and global financial crisis as well.The sixth and last chapter discusses on the risks of capitalization of Chinese foreign reserves. The capitalization of foreign reserves is a"double-edged sword", because it gains returns via various modes of investment but simultaneously faces various kinds of capitalization risk . On one hand, the accumulation of foreign reserves may result in financial costs of holding them and the risk of realizing the objectives of monetary policy, and on the other hand, the investment and operation of foreign reserves may encounter foreign reserve risks such as exchange rate risks, interest rate risks, liquidity risks and credit risks. The instability of global economic development further exacerbates the said risks. And the eruption of global financial crisis, the deterioration of European sovereign debt crisis, the raise in American sovereign debt ceiling, and the downgrading of sovereign credit ratings of many developed countries all intensify the foreign reserve risks arising from our investments in U.S. bonds and European bonds. Therefore, China should establish a multi-tier and diversified foreign reserve risk management framework to mitigate or diversify away the excessive foreign reserve risks, and facilitate the harmonized development in China, United States and even global economy via value-assurance-and-enhancement of foreign reserves under risk constrains.