The Falling Dollar And China's Foreign Exchange Reserves

by: Wolf Richter

Stiffened capital controls help.

The weak dollar, China’s complex web of capital controls, and its efforts to crack down on its huge and over-leveraged conglomerates to invest overseas are having an impact:

China’s foreign exchange reserves – the largest such pile of foreign-currency-denominated securities in the world – rose by $21 billion in December to finish the year at $3.14 trillion, according to the People’s Bank of China today. It was the highest level since September 2016 and the 11th month in a row of gains since the panic-moment in January 2017 when reserves had fallen below $3 trillion. Clearly, at $3 trillion, authorities drew a line (chart via Trading Economics):

Over the 12-month period, foreign exchange reserves rose by 4.6%, or $129 billion, the first annual increase since 2014, which was the year when forex reserves peaked at nearly $4 trillion before starting into a downward spiral as Chinese individuals and companies were trying to get their money out of the country, as the yuan was sinking against the dollar, and as a little while later, Chinese stocks crashed from astonishing bubble highs with astonishing speed.

In 2017, as authorities were trying to stem capital outflows, the yuan, which is pegged against the dollar, also rose for 11 months in a row against the dollar.

Seen another way, the dollar fell against the yuan in 2017, but it also fell against other currencies. 2017, based on the broad trade-weighted dollar index, was the worst year for the dollar since 2003. It currently takes 6.49 yuan to buy a dollar. A year ago it took about 6.97 yuan.

The falling dollar has reduced the heat from under Chinese individuals and companies trying to get their money out – which might have helped slowing the outflows.

But how much, if any, of the 4.6% increase in the foreign exchange reserves last year is due to actual increases in foreign exchange instruments, and not just due to the decline in the dollar?

Authorities have already admitted that at least some of the rise of the reserves last year is due to the decline in the dollar against other currencies. The values of non-dollar currencies in the reserves are translated into US dollars. So a decline of the dollar against those currencies would increase the dollar level of those non-dollar holdings.

For example, the euro soared 14.5% against the dollar in 2017, the Canadian dollar rose 7%, and the Japanese yen nearly 4%. Even if the level in China’s reserves of those currencies has not changed in absolute terms, it would have risen sharply because the dollar, into which they’re translated for publication purposes, has tumbled.

So the rise of China’s foreign exchange reserves is a mixed bag: perhaps an indicator of the effectiveness of the capital controls and certainly an indicator of the tumbling dollar.

And for now, China does not appear to be relenting in its controls to stem capital outflows. On the contrary.

In December, for example, the State Administration of Foreign Exchange announced that individuals are allowed to withdraw a maximum of 100,000 yuan ($15,400) a year from their Chinese bank accounts while overseas, in total, spread over however many separate bank accounts or ATM cards they may have. Until then, they could withdraw 100,000 yuan per card. So if they had multiple cards and accounts with several banks, they could convert a lot of yuan into USD while overseas. This no longer works.

In the same vein, earlier in 2017, the National Development and Reform Commission, China’s economic planning agency, has increased its scrutiny of outbound acquisitions by private Chinese firms and has brought their overseas subsidiaries under its oversight.

Sunday, the State Administration of Foreign Exchange said as part of its announcement, reported by the South China Morning Post, that it would keep foreign exchange reserves and international balance of payments “balanced and stable” in 2018. SAFE cited the decline of the dollar against other currencies in December as one of the reasons for the increase in the dollar value of China’s forex reserves. And this dollar value of the non-dollar portion of its forex reserves is an accounting entry, more dependent on the value of the dollar than anything else.

Central banks are leery of the newly arrived Chinese yuan. Read… US Dollar Refuses to Die as Top Global Reserve Currency