How Did China Build Up Its Reserves?

May 26, 2016


China has quite a lot of reserves, as we saw on one of the first couple graphs. How did China accumulate these reserves? Well, let's go through it mechanically so that it becomes clearer.

First, we know, or you may know, that on average, on net, China sells a lot more goods and services abroad than it imports. And the counterpart to selling more goods and services abroad than you import is that you have to import a lot of assets. Because they're not going to give goods and services away, right?

So they sell goods and services abroad, but they import assets which are claims on future consumption. How does this work mechanically? Well, Chinese firm-- a Chinese firm might sell goods abroad for $1, say. The Chinese firm would then take the dollars that they just got for those goods and they would take it to a foreign exchange bank and exchange it for the Chinese currency.

The People's Bank of China would then buy those dollars from the foreign exchange bank. Ordinarily, for those of you who are boffins in the audience about monetary economics, ordinarily, this is going to expand the domestic money supply, but the People's Bank of China takes various steps to reverse this domestic money supply expansion. In any case, the People's Bank of China ends up with the dollars, and then the People's Bank of China buys assets, say, from the U.S., with the dollars. And again,

I'm using the dollar, but I could also use the euro, or the yen, or other reserve currencies.

For many years, China has exported more goods than it has imported. This has led to an increase in its reserves of foreign assets. In this video from the most recent Dialogue with the Fed event, St. Louis Fed Assistant Vice President and Economist Christopher Neely explains the mechanics of how China came to accumulate its significant store of foreign exchange reserves.

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