China's Foreign Exchange Reserves On An Appropriate Scale Study

The foreign exchange reserve is the "buffer" of a country's financial system. Sufficient foreign exchange reserves are important for a country to adjust its balance of payment, intervene in the foreign exchange market, stabilize its exchange rates, prevent and reduce financial risks such as foreign exchange speculation. Therefore, the foreign exchange reserve suggests both economic and financial power of a country.The foreign exchange reserve of China has been growing fast since the reform of foreign exchange reserve management system in 1994. Especially after we entered into WTO in 2001, China keep enjoying surplus balance of both current account and capital account, which led to a 40% annual growth rate of foreign exchange reserves. At the end of 2006, China had $1,066 billion foreign exchange reserves, exceeding Japan and ranking NO. 1 in the world. By the end of 2008, the amount has reached $1,946 billion, about 12 times of the amount in 2000. Such large amount of foreign exchange reserves has aroused wide attention from both foreign and domestic economists.Despite the positive effects, redundant foreign exchange reserves are a waste of resources and will have other negative impacts on economy. Hence, the amount of one country's foreign exchange reserves should be moderate, adapting to its economic development. This paper combined factor analysis and cost-benefit approach to study the moderate scale of China's foreign exchange reserves. This paper divided the demands on foreign exchange reserves into five parts: transactional demand, adjustive demand, repayment demand, preventive demand, and demand on FDI profits remittance, and then, it modified the Agarwal Model according to the situation in China, analyzing the costs and benefits of each part to calculate the moderate scale of China's foreign exchange reserves.Based on the study of economic statistics from 1990 to 2008 of China, this paper drew a conclusion that since 2004, China's foreign exchange reserves has exceeded the moderate scale estimated by this paper, which means the total cost of China's foreign exchange reserves has outrun its total benefit, and the gap is becoming larger and larger. Thus, China needs to take powerful measures to improve the effectiveness of foreign exchange reserve management. Current suggestions on the management and utilization of China's foreign exchange reserves can be concluded as the following: price adjustment, quantity adjustment, and enrichment of investment instruments. The last chapter of this paper analyzed these prevalent suggestions, concluded that these were not the appropriate choices for China in short term, and then, gave advice on both short-term and long term policies to deal with the rapid growth of China's foreign exchange reserves and ensure health economic growth.