China’s exchange reserves at issue

The thorniest problem in economic relations between the United States and China is getting worse, just as the world’s two biggest economies prepare for a summit next week in Washington.

At issue is the imbalance in their financial relationship. China’s central bank said Tuesday that Beijing’s holdings of foreign cash and securities amount to $2.85 trillion – a jump of 20 percent over the year before – despite Chinese promises to try to balance its trade and investment relations with the United States and other countries.

China added $200 billion to that stockpile in the last three months of the year alone, as the country socked away capital from the rest of the world at a torrid pace.

The reserves are so large and the recent run-up so rapid that it’s casting new doubts over whether Beijing is reforming the handling of its currency and curbing its heavy reliance on exports as a source of jobs and growth.

Relations between China and the United States have been rocky on several fronts. The agenda for discussions between presidents Obama and Hu Jintao include military tension on the Korean Peninsula, and North Korea’s nuclear program; competition between Washington and Beijing for influence throughout Asia; human rights; trade; and even concerns about the security and intelligence implications of China’s involvement in the U.S. telecommunications sector.

Concern over China’s economic policies have mounted as its reserves have grown to roughly a third of the $9.1 trillion dollars in foreign exchange holdings that all central banks reported to the IMF in 2009. China’s holdings are more than those of Japan, Russia, South Korea, Taiwan, Saudi Arabia and the euro-zone countries combined.

Foreign exchange holdings are a broad measure of a nation’s economic links with other countries, reflecting exports and imports, investment and the flow of speculative “hot money” into local markets. Some reserves are helpful, and Asian nations in particular, stung by their financial crises in the 1990s, seek to keep a war chest for times of trouble.

But with China’s foreign currency holdings far exceeding those of any other country, it has been urged by the United States, International Monetary Fund and others to import more, allow its exchange rate to rise in value, and use some of the reserves, for example, to boost the purchasing power of Chinese citizens. Although some recent statistics have shown a move in that direction – the country’s trade surplus has narrowed for the past two years, as China’s imports grew faster than exports – the surge in reserves is a pointed reminder of the difficult questions that still face Hu and Obama.

On the economic front, the two sides have worked to set an amenable agenda, signing a series of agreements in mid-December that administration officials say will help a diverse set of American companies – from ranchers to software engineers and wind turbine manufacturers – do better in the Chinese market. Final details are being settled now, with an aim of announcing them while Hu is in Washington.

But this has in many ways been a troubled phase in relations between the world’s top two economies. The United States continues to run more than a $200 billion annual trade deficit with China; the Commerce Department has imposed dozens of anti-dumping and other levies against Chinese companies accused of competing unfairly; U.S. businesses have increasingly complained about Chinese rules that favor local competitors and block out foreign firms.

The spike in reserves is likely to feed what one Obama administration official said was frustration over one core issue in particular: the value of China’s exchange rate. That issue prompted the House of Representatives to vote in favor of a special tax last year to offset what congressional leaders deemed China’s “currency manipulation.” The Senate did not take a similar vote.

The renminbi, also known as the yuan, is considered by a wide range of economists to be undervalued in relation to the dollar, and China keeps tight control of the exchange rate, in part to protect its powerful export industries.

Keeping the local currency at an artificially low level, however, contributes to inflation and a host of other problems that Chinese regulators are now trying to combat, for instance by hiking interest rates and increasing bank reserve requirements. It has become a test, in some ways, of the government’s commitment to currency reform: If ever there was a time to let the renminbi rise in value it is now, analysts say, and the fact that it hasn’t casts doubt on the country’s intentions.

China said in June it would allow the exchange rate to rise in a controlled way and earned compliments from the United States for a steady appreciation of about 3 percent through the fall. But since then, the effort has stalled, despite signs that money continues to flood into the country, including rising property values and a boost in bank lending. Allowing the exchange rate to rise would temper those trends by making Chinese goods more expensive and discouraging speculators.

An administration official, who spoke anonymously because of the sensitivity of discussions between the countries, said that it is an ideal time for China to let its currency float more freely. The lack of progress shows that the country’s export lobby still has the upper hand, the official said.

Officials at the Chinese Embassy in Washington did not comment for this article.

In recent months, the Chinese have have blamed U.S. policy for some of the difficulties they are facing, in particular warning that the Fed’s decision late last year to stimulate the U.S. economy through massive bond purchases would likely boost the flow of speculative money into China and other emerging markets.

Pieter P. Bottelier, a China expert at Johns Hopkins University’s School of Advanced International Studies, said the record rise in China’s reserve holdings over the last three months of 2010 cannot be fully attributed to the country’s trade surplus or entirely blamed on its exchange rate policy. But he also said it is becoming increasingly clear that China’s exchange rate policy is exacting a cost as the country tries to control prices and speculation in its real estate and other markets.

“They have done themselves and the world a disservice,” Bottelier said. “They’d be better off if they would be more aggressive” in allowing the renminbi to rise in value. “The export-oriented model is not sustainable. But they have done the opposite and protected the export lobby.”