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by William Pesek
February 03, 2010, Bloomberg Business Week
Commentary by William Pesek
Feb. 4 (Bloomberg) -- Real estate, stocks, credit.
China sure has its share of bubbles. Oddly, little attention is paid to
the biggest one of all.
China’s currency reserves grew by more than the
gross domestic product of Norway in 2009. Its $2.4 trillion of reserves
is a bubble all its own, one growing before our eyes with nary a peep
out of those searching for the next big one.
The reserve bubble is actually an Asia-wide
phenomenon. And we should stop viewing this monetary arms race as a
source of strength. Here are three reasons why it’s fast becoming a
bigger liability than policy makers say publicly.
One, it’s a massive and growing pyramid scheme. The
issue has reached new levels of absurdity with traders buzzing about
crisis-plagued Greece seeking a Chinese bailout. After all, if
economies were for sale, China could use the $453 billion of reserves
it amassed last year to buy Greece and Vietnam and have enough left
over for Mongolia.
Countries such as the U.S. used to woo the Bill
Gross’s of the world to buy their debt. Now they are wooing
governments. Gross, who runs the world’s biggest mutual fund at Pacific
Investment Management Co., is still plenty important to officials in
Washington. He’s just not as vital as the continued patronage of state
asset managers in places like Beijing. Next Step
You have to wonder what folks at the International
Monetary Fund are thinking these days. Their aid packages tend to come
with messy requirements, such as “get your economy in order.” China’s
are merely about scoring resources or geopolitical points. We have
already seen China throw lifelines to Wall Street giants, including
Morgan Stanley. Entire countries seem like the natural next step.
China’s huge arsenal of reserves is increasing its
global influence. The trouble is, China is trapped in an arrangement of
its own making. As China and other Asian nations buy more and more U.S.
Treasuries, it becomes harder to unload them without causing huge
capital losses. And so they keep adding to them.
“This is a titanically large foreign-exchange
trade,” says David Simmonds, London-based analyst at Royal Bank of
Scotland Group Plc. “It’s the biggest one history has ever seen and
there’s nowhere for these reserves to go.”
China aims to diversify out of U.S. Treasuries into
other assets and commodities. The question that governments are
grappling with is which markets are deep enough to absorb China’s
riches? Gold? Oil? Euro-area debt? The Madoff family’s next Ponzi
scheme? Ending Badly
The challenge for China alone is like trying to park
an Airbus A-380 super-jumbo in a Volkswagen. Like all pyramid schemes,
there’s no easy end in sight and things could end badly. If the dollar
collapses, panicked selling by central banks looking to limit losses
would shake global markets more than the U.S. credit crisis has.
Two, reserves are dead money. The wisdom of currency
stockpiling came from the chaos of 1997. Speculators sensed authorities
in Thailand were sitting on few reserves, and they were right. Their
attack on the Thai baht set the stage for an Asian meltdown.
Governments spent the 2000s determined not to repeat the mistake.
Asian economies have too much of a good thing on
their hands. In July 2007, on the 10th anniversary of Thailand’s
devaluation, Asian Development Bank President Haruhiko Kuroda said the
accelerating accumulation of reserves was a major concern for the
region. Too bad nobody listened to him.
Vast Sums
These huge sums of money could be used to improve
infrastructure, education, health care and reducing carbon emissions.
Never before have we seen such a misallocation of such vast resources.
Asia can do better with its money.
Three, reserves add to overheating risks. When
policy makers buy dollars, they need to sell local currency, increasing
its availability and boosting the money supply. Next they sell bonds to
mop up excess money in economies. It’s an imprecise science that often
leads to accelerating inflation. The strategy works out to be an
expensive one.
The stakes are rising fast. The risks in Asia are
skewed firmly in the direction of inflation. The focus is now on
central banks to see if they will pull liquidity out of economies with
higher interest rates. More attention should be on how reserve
management is working at odds with that goal.
Central banks face a difficult task. They must
withdraw excess liquidity without devastating their economies and
running afoul of politicians. Only now is Asia finding out how some of
its economic-protection tactics are amplifying the challenge.
Asia has been holding down currencies to support
exports for more than a decade. It’s silly to ignore the side effects
of that strategy for the region’s economies.
Think about how Dubai shook the global economy, or
how the mere hint that Chinese growth may dip below 8 percent inspires
panic. These disappointments pale in comparison with the turbulence
that may come from Asia’s biggest bubble popping.
To contact the writer of this column: William Pesek in Singapore at +81-3-3201-7570 or
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To contact the editor responsible for this column: James Greiff at +1-212-617-5801 or
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