Understanding China’s Forex Reserves.doc

Understanding China’s Forex Reserves 　　Statistics issued by Chinas central bank in early February revealed that China’s foreign exchange（forex） reserves stood at $2.9982 trillion at the end of January， a drop of $12.3 billion compared to the previous month. Upon receiving the data， some analysts expressed concern， claiming that Chinas forex reserves had breached the psychological threshold of $3 trillion. The so-called “$3 trillion psychological threshold，”however， is neither a scientific nor an accurate expression， as a countrys forex reserves are not a fixed number but something that keeps fluctuating according to a set of fi nancial activities like the country’s inbound and outbound investments， as well as residents forex activities. The forex reserves are crucial for China’s economy. Concern for the psychological line of demarcation is essentially apprehension over whether the reserves will continue to decrease. Here， we have to clarify two questions： First， why has the amount fallen？ Second， what amount would China consider to be appropriate？ The forex reserves relate to the internationalization level of a countrys economy. Since 1978， the year China began adopting the policy of reform and opening up， the nation has attracted a huge amount of international investment and registered a favorable balance of trade. This led to the accumulation of Chinas forex reserves， which jumped from $167 million in 1978 to $3.84 trillion in 2014. These figures once triggered concern among Chinese economists， who were afraid that the fl ood of foreign capital would affect the economy negatively. Meanwhile， the practice of solely purchasing U.S. treasury bonds for hedge was widely criticized. Since 2014， Chinas forex reserves have been in decline. There are several reasons for this trend. To begin with， other major foreign currencies such as the euro are depreciating against the U.S. dollar. Since part of Chinas forex reserves are in these currencies， their d