Q11: Will China use its foreign exchange reserves as a trump card or as an atomic weapon?
A: We have always emphasized our role as a responsible long-term investor. During the investment and operations of our foreign exchange reserves, we will strictly follow the rules of the market and the laws and regulations of the country concerned. Meanwhile, we will use the reserves as a financial investor and will not seek control over those investments.
The investment and operations of foreign exchange reserves must be mutually beneficial; therefore, we let things run their natural course, so to speak, which means we will actively cooperate with those countries that welcome our investment. But if any country is doubtful, we will slow down and try to reach agreement through communications.
As has been proven by the facts, the above concerns and worries are completely ungrounded.
Q12: We know that the US fiscal deficit is surging, but what does that mean for the US dollar?
A: Any prediction on trends for the US dollar must be based on the economic situation not only in the US, but also that in other countries. In the wake of the financial crisis, the US launched massive financial bailout initiatives, resulting in a mounting fiscal deficit and worries about a further depreciation of the dollar. However, we must bear in mind that the weakening of the dollar is also related to the currencies of other countries and regions, which have their own problems. Countries in Europe, for example, are deep in debt. As can be seen from recent developments, the US dollar is strengthening against some currencies, including the euro. From the end of 2009 to May 2010, for instance, the US dollar rose 20 percent against the euro. Going forward, whether the dollar will go up or down will depend on the prospects for an economic recovery in the US and the entire world, as well as on the economic policies of the major economies including those of the US.
We hope that major global issuers of currency, the US in particular, will adopt responsible policy measures, fully take into account fiscal deficit pressures and threats of inflation, appropriately arrange an exit mechanism for the loose monetary policies, reduce reliance on debt expansionary policies, shoulder the responsibility and obligation to maintain currency stability, and protect the interests of investors.
Q13: Will more or less of Chinas foreign exchange reserves go into US treasuries?
A: The US treasury market is the largest of its kind in the world. Given its safety, liquidity, large market volume, and comparatively low transaction costs, for a long time it has been favored not by only domestic investors (over 50 percent of government debt is bought within the US), but also by international investors, including the major central banks throughout the world. As Chinas management of its foreign exchange reserves emphasizes safety, liquidity, as well as maintenance and added value, based on our needs and judgments, we tend to diversify our allocation of assets on international financial markets and the US treasury market is an important market.
For a long time, there has been speculation whether China will buy more or less US treasuries with her foreign exchange reserves. It has even been stated that Chinas massive holdings of US dollar assets constitute a threat to the US. The truth is that using foreign exchange reserves to buy American treasury bonds is an investment behavior on the market, and the same is true for an increase or decrease in holdings. Fluctuations in economic cycles and changes in supply and demand, among other factors, can lead to ups and downs in treasury debt prices, and changes in other asset prices can also affect the comparative attractiveness of treasuries. Based on these observations, we have been closely following and analyzing various changes in the market and constantly making dynamic optimization and operational adjustments. This should not be interpreted politically.
The outbreak of the recent financial crisis prompted the US to adopt monetary and fiscal stimulus policies, resulting in a sharp increase in the fiscal deficit and a greater share of outstanding national debt in GDP, hence producing worries about the safety of assets in the US. Chinas foreign exchange reserves are engaged in long-term diversified investment, with dynamic changes among different assets, in order to effectively control the overall risks, to allow sufficient liquidity, and to achieve overall stability of value. Meanwhile, China has been calling on the US to act as a responsible power by taking concrete measures to safeguard US and global economic sustainability, to protect the interests of investors, and to uphold their confidence.
Q14: Are foreign exchange reserves mainly invested in relatively high-grade treasury bond assets?
A: Foreign exchange reserves are mainly invested in financial products with relatively stable investment income and low risks, which mainly include assets related to governments, institutions, international organizations, and corporations in the developed and major developing countries, and mutual funds and various other products such as inflation-protected bonds and asset-backed securities.
We need to take into consideration many factors in the allocation of our foreign exchange reserves and we do not merely buy products with high-grade investments. China now has more than two trillion dollars of foreign exchange reserves. With so much capital, many factors are taken into consideration when purchasing financial products, such as the market capacity of the invested products. If the treasury bonds of a nation enjoy high credibility and repayment capability, but are only several hundred million or several billion US dollars, and are traded mainly on the domestic market and are seldom available on the international financial market, then such products can hardly satisfy our investment demands. In addition, whether the assets risk-return characteristics and related functions can meet our portfolio investment needs and requirements for risk diversification, and efficiently withstand inflation are all important factors that need to be considered.
Our foreign exchange reserves are a stable, responsible, and long-term investment in the international financial market and we never engage in speculation. Active speculators in the international financial market go after arbitrage opportunities, and some of them even take the initiative to create them. In contrast, foreign exchange reserves seek to maintain or increase the value of assets, putting the safety of the reserve assets at top of the agenda. All of these operational ideas are conducive to the stability of the international financial market.
Q15: Are foreign exchange reserves invested in higher-risk financial products such as stocks and private equity? What is the size of such investments?
A: We have strict investment standards and risk management procedures for the various assets that can be invested with foreign exchange reserves. When choosing varieties of investment, it is imperative to consider their safety, liquidity, long-term and short-term returns on investment, and other characteristics. Meanwhile, it is also necessary to take into account the correlations with other assets. Putting low correlated or negative correlated assets in the same portfolio can offset each other at different stages of the economic cycle, which is conducive to reducing the overall risk and to enhancing the flexibility of asset allocation and risk management.
We do not rule out any investment products. But strict risk assessment and control are needed to decide upon which product we should invest in. In other words, according to the above-mentioned standards, it is necessary to determine whether the products are in line with the principles of safety, liquidity, and maintenance and increments of value of the foreign exchange reserves, and whether they can achieve the effect of risk diversification. As soon as they meet these standards, they will be included in our decision-making and risk management procedures.
Q16: Is China considering further increasing its gold holdings? And when?
A: Gold has many advantages, such as high international recognition, a good capability to maintain value, and an ability to make emergency payments. Meanwhile, investment in gold is subject to certain restrictions, which makes it impossible for gold to become our main channel for foreign exchange reserve investment.
First, gold has a very limited market capacity. Annual global gold output is only 2,400 tons, and current demand and supply is basically balanced. If we buy gold on a large scale, the international price of gold will definitely be pushed up. When Chinese people go shopping malls to buy commodities like gold jewelry, they would be faced with rising prices, which would end up hurting the interests of our domestic consumers. Chinas gold price is generally in line with that of the world market.
Second, gold prices fluctuate considerably. As the international price of gold is subject to the impact of the geopolitics of interest rates, supply-demand relations, and speculation, they often fluctuate sharply. In addition, gold does not bring interest income and bears the costs of storage, transportation insurance, and so forth. Based on the history of the past thirty years, the risk-return characteristics of gold are not that good. Gold is protected from inflation, but many other assets have this characteristic as well.
Last, increasing gold holdings does not have a notable overall effect on the diversification of foreign exchange reserves. During the past several years, China has increased its holdings of gold reserves by over 400 tons, reaching total holdings of 1,054 tons. Even if this were to be doubled, it would only disperse thirty to forty billion US dollars of our foreign exchange reserves, raising the proportion of gold reserves by merely one to two percentage points.
In general, we will take a prudent approach when considering whether to increase or decrease our gold reserves according to demand and the market.
(To be continued)