The Chinese paradox...

As many people may have heard, the Chinese have vast reserves of foreign currency which they are holding onto and may use to buy the ENTIRE WORLD (or something like that).

At the moment, those reserves are apparently in the order of some $1.4 trillion US. In other words, an awful lot of money.

This article is a great read explaining why the Chinese are doing what they're doing and what the ramifications are.

Basically, the Chinese are getting lots of foreign currency, because they're selling lots of stuff overseas. The vast majority of this currency is being put into safe, long term investments, such as treasury notes and bonds, the majority in US dollars.

By doing this, they are deliberately keeping themselves poor (at least functionally) and ensuring that they stay competitive on a world stage. As an added benefit, the vast amounts of US dollars the Chinese hold are helping to hold up the US economy by keeping the dollar strong and interest rates low. If the Chinese stopped pumping in all this cash the US govt would have to borrow from elsewhere, probably at much higher rates.

By keeping the dollar strong and rates low the Chinese are in effect subsidising the American people (to a significant amount) and thereby enabling them to buy yet more stuff, from the Chinese.

Of course, this isn't much fun for all those poor Chinese people who would quite like some of that money to be spent at home, on things like, say, heaters in schools in areas with blizzards in winter.

However, the Chinese are now in a quandry. If they start pulling their money out, the value of the dollar will fall, thereby lowering the value of the rest of their investments. Not only that, the Chinese currency would rise, making it harder for exporters and the ramifications for govt spending and the economy in the US would be huge. Suddenly the Americans wouldn't be able to buy as much stuff from the Chinese. This ends up in a huge downward spiral.

So rationally, the Chinese can't do anything because they're stuck.

Except, lets face it, people aren't rational, especially crazy, paranoid communist party members convinced that the US is out to get them. Forget the GFC, apocalyptic world economy collapse anyone?

It's a fascinating article, you should definitely read it.

cheers

Dr Harry