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Beijing Defends Strategy on Foreign-Exchange Reserves
BEIJING—The agency that manages China's foreign-exchange reserves struck back against domestic critics of its handling of the enormous cash pile, while also calling on the U.S. to protect the interests of its creditors.

It wasn't clear what prompted the statement Wednesday by the State Administration of Foreign Exchange, but it reflects the political sensitivity of China's foreign-exchange reserves—the largest of any country's, at $3.197 trillion. Some Chinese critics have complained those reserves are being poorly invested and are over-concentrated in U.S.-dollar assets such as Treasury bonds, of which China is the world's largest holder.

A debate in Washington over how to handle the growing U.S. debt has increased concerns in China and other countries about the safety of their investments in America.

The foreign-exchange administration, known as SAFE, rebutted the arguments of its domestic critics in an unusually forceful tone in Wednesday's statement, posted on its website. It argued that depreciation of the dollar against the yuan—Beijing has let its currency rise slowly over the past year—causes losses on the reserves only "on paper," when they are converted to yuan. Since the reserves are all held in foreign currency and invested abroad, that conversion doesn't actually happen.

"This is not a real loss, and has no direct effect on the external purchasing power of the reserves," SAFE said.

By the logic of the critics, the statement said, a fall in the yuan's value would increase the value of the reserves and benefit society. "But in fact," it went on, "yuan depreciation wouldn't increase returns on value forex reserves, and it's even less possible that it would add to society's wealth."

Many critics have demanded that the government diversify its holdings by purchasing commodities. But SAFE dismissed that argument, too. China cannot buy assets like gold and oil in large quantities without pushing up their prices, which would hurt the interests of domestic consumers of those commodities, it said. It also noted that such commodities are prone to large price fluctuations, and impose high transaction and storage costs.

One prominent critic of SAFE's practices has been Yu Yongding, a former adviser to the central bank and currently an academic at the state-run Chinese Academy of Social Sciences. In an April paper, he described U.S. Treasury bonds as a giant "Ponzi scheme" supported through purchases by the Federal Reserve. Dollar depreciation is causing capital losses on the reserves, and their purchasing power has fallen relative to commodities like gold and oil, he argued.

Similarly, in a paper published earlier this month, Zheng Xinli, vice president of the state-run China Center for International Economic Exchanges, wrote that every percentage point decline in the dollar—he didn't specify against which currency—causes capital losses to China of more than $10 billion. He called for the reserves to be diversified into commodity and energy assets.

The potential risks to China's holdings of U.S. Treasury instruments have been spotlighted by the political debate in the U.S. over the debt ceiling and the possibility that a failure to raise the ceiling in time could lead to a U.S. default. China keeps the composition of its reserves a secret, but it's widely believed to be held mostly in dollars, with most of that in Treasurys. According U.S. government data, China's holdings of Treasury securities totaled $1.159 trillion at the end of May, although those estimates are thought to understate the true total.

In its statement Wednesday, SAFE said it has "taken note" of recent comments on U.S. debt by ratings firms such as Standard & Poor's. Last week, John Chambers, a managing director at S&P, said the firm may downgrade U.S. sovereign debt if Congress hasn't raised the debt ceiling by later this month.

SAFE called on the U.S. to "take responsible actions to strengthen the confidence of international financial markets," and reiterated earlier calls by the Chinese government for the U.S. to "respect and protect the interests of investors."

The SAFE statement said "the excessively fast growth of reserves and the excessive scale of reserves" does lead to "certain challenges" in their management, but argued that the key to addressing the problem is reducing the scale of China's external imbalances.

China's large surpluses in the capital and current account lead the buildup of reserves, as the central bank buys up foreign currency entering the country from foreign investors, exporters and others.

Source: Wall Street Journal Online--http://online.wsj.com/article/SB ... 57284041435522.html