Q: Recently there have been comments by scholars that since 2003 China has suffered a huge loss of USD271.1 billion in its foreign exchange reserves, due to the appreciation of the RMB against the US dollar. What is your comment on this?
A: First, the appreciation of the RMB will not bring about losses in Chinas foreign exchange reserves. Foreign exchange reserves essentially are assets in foreign exchange, which use the USD as the recording currency. Variations in the RMB/USD exchange rate will result in changes in the book value of RMB converted from the foreign exchange reserves, which are not the actually realized gains or losses. The variation only means some differences in the book value of the reporting currency, be it RMB or USD, and does not have a direct impact on the effective purchasing power of the foreign exchange reserves. The changes in the exchange of currency will only occur when foreign exchange reserves are repatriated from overseas countries (regions) and converted into RMB. Presently, China has no need to repatriate and settle its foreign exchange reserves on a large scale. In addition, equivalent incomes in RMB were attained by banks, enterprises, and individuals when foreign currencies were sold; the appreciated RMB generated considerable benefits in lowering the costs of imports, increasing incomes from investment, and so forth. That is to say, the benefits have been retained within the country.
Second, the book loss of foreign exchange reserves caused by the RMB appreciation is far less than the book surplus of Chinas financial assets. The book loss and surplus generated from the reporting currency are like two sides of a coin (in economics called duality). In contrast to book losses of RMB converted from foreign exchange reserves which are denominated in USD, if converted to USD China enjoys a book surplus of RMB financial assets held by citizens. As of the end of March 2011, Chinas balance of foreign exchange reserves reached USD3.04 trillion. Converted at the end-March 2011 exchange rate, the total scale of RMB financial assets, such as RMB deposits of enterprises and individuals, stocks, treasury bonds, and insurance assets during the corresponding period was more than five times that of Chinas foreign exchange reserve assets. This means that when the RMB appreciates, the book gains of RMB assets is over 5 times the book losses of the foreign exchange reserve assets. Furthermore, the book gains of RMB assets will become more substantial when property assets and other kinds of financial assets held by residents in forms of stocks, bonds, and so on are taken into account. Likewise, in essence the above losses or gains are variations in book values. That means the variations will not be realized as gains or losses if the currency is not exchanges.
Third, the effective purchasing power of foreign exchange reserves depends on the yield of foreign exchange reserves and the inflation rate of the countries where the investments are made. China has maintained stable gains from its foreign exchange reserves operations over the years; the yields of operations far exceed the inflation rate of the countries (regions) where investments have been made, such as the U.S., Europe, or Japan, thereby ensuring the effective purchasing power of the foreign exchange reserves. During the 2000-2010 period, the consumer price index (CPI) in the U.S., Europe, and Japan increased at an annual rate of 2.4 percent, 2.1 percent, and -0.2 percent respectively. In the meantime, China has seen a far higher average annual operating yield from its foreign exchange reserves.