Art Scene in China

Today’s Links:

• China to become the next art superpower?
• The auto industry ramps up production of luxury cars in China. On a related note, GM will also open an additional 600 dealerships as well.
• Huawei’s net profit falls by 53 %
• Chinese manufacturers begin to experience a rebound
• Hollywood’s move to the East to hit a possible roadblock with bribe investigations
• LVMH launches new site to reach Chinese consumers
• The Lancet’s China themed issue takes a look at the healthcare system

Photo credit: nuomi

Here are today’s China links:

• China’s domestic consumption to rise 15 % and drive growth in 2012
• China Construction Bank’s growth expected to slow down despite rise in profits
• Chinese airlines begin to target international markets with expansion abroad
• Meanwhile, China Eastern and Qantas join forces to set up a budget airline
• Apple’s Tim Cook visits China
• Huawei to ask Australia to reconsider them for a broadband project after being banned

Owning a car in China is becoming more expensive as the price for a car license plate in Shanghai reaches a record high. At the most recent auction for license plates, the price for a plate hit 58,625 RMB. Despite the high prices for plates, demand continues to rise. In February 23,391 bidders competed for plates. In March, the number of bidders increased to 24,897.

The chart above compares the price of a license plate in Shanghai to the number of plates.

For more details visit this link (Mandarin).

The new book China’s Economic Supertrends, coming out on April 18th, also covers the Shanghai license plates auctions and Beijing license plate lottery. To read more about this phenomenon, here is a short excerpt from the new book below:

The World’s Most Profitable DMV

Since 1994, in a bid to keep Shanghai’s high-spending consumers from flooding the roads with cars, Shanghai has had a cap on the number of new license plates. At present, it releases about 5,000–10,000 new plates per month, which it sells at a monthly auction.

In many years, the amounts raised from this activity are significant, as much as half a billion dollars or more for the city to use on subsidizing public transport. More importantly, the system acts as a disincentive on the purchase of new cars, reducing road congestion and pollution. It is not without controversy, being opposed by car buyers, while most transit users support it. The controversy mostly arises from a lack of transparency as to how the funds are being used.

In 2007, the once-a-month license plate auctions generated about $500 million in annual revenue, while the 2010 auctions raised a total of $659 million for the city, probably making it the most financially lucrative Department of Motor Vehicles in the world. Most of this money was used to improve local public transportation facilities and subsidize public transportation costs. The amount left over each year is published, but detailed spending figures are not yet available.

With the car craze unabated, monthly auctions during the last two years saw high demand and high prices for plates. In fact, the price of a plate can be as much as eight to 16 months’ salary for a typical office worker, yet consumers seem willing and able to continue to pay the high tax. Sixes and eights are important in Chinese numerology, so plates with auspicious numbers such as 888 are even more expensive and can go for astronomical amounts.

Prices rose to a record average price of 58,625 yuan ($9,305) per plate in March 2012. This price level can actually eclipse the price of an economy car, such a Chinese-made Chery QQ, which goes for about 51,000 yuan ($8,095). With the plate nearly doubling the cost of a small car, many people try to register their cars in nearby provinces where the plate costs are lower. But, in recent years, this circumventing of the rules has become more complex and expensive. In fact, the high plate prices in Shanghai could actually be having a negative impact on the environment: many consumers use the high plate price as a justification to get a more expensive car, which will likely have a higher displacement engine and emissions, increasing China’s carbon footprint and local pollution. It is a good example of the sometimes unintended consequences of an economic policy. On the one hand, fewer cars are on the road. On the other hand, the cars that are on the road are bigger and less fuel-efficient.

Nevertheless, using this plate system, Shanghai has been able to limit itself to 80,000 to 110,000 new cars on the road each year, and make a lot of money in the process. That one of China’s largest cities is able to do this is probably a good thing, considering the Chinese nationwide are purchasing more than 10 million vehicles a year now, and China is the world’s largest market for automobiles. In 2012, Shanghai had about 1.3 million public vehicles and 1.2 million private cars on its roads. Without the controls on new plates for cars purchased by Shanghai’s 22 million residents, Shanghai would likely find itself overwhelmed with cars, much the same way Beijing already is.

Want to read more? Pre-order China’s Economic Supertrends on Amazon.com today.

Photo: Robert Scoble

Here are today’s China news links:

• Manufacturing in China continues  to slow.
  
• In the meantime, clothing factories shift production away from China and  go West
• China likely to give go ahead on Google-Motorola
• Law drafted in China to encourage good Samaritans who lend a helping hand
• Outlook for China’s banking sector takes a downturn

China links of the day:

• China’s property prices continue to fall
• Steel industry in China negatively impacted by the slowdown of high speed rail development and construction projects
• Schools in East Asia, including some Chinese universities, are inching their way up school rankings.
• IMF’s Legarde suggests that China must wean itself off from exports and investment
• The Economist on Bo Xilai’s downfall

From Voxy.com

• The Globe and Mail takes a look at the counterfeit wine trade in China.
• China moves to make the yuan more international by allowing  Japan to purchase 10 billion in state bonds. In the meantime, China also moves to push economic reforms.
• Trade tensions unearthed between the United States and China regarding the export of rare earth metals. Update: It may be too late.
• Politicians in China begin to make campaigning moves. Let the games begin.
• Popular online video companies Youku and Tudou to merge.

Photo credit: DavidDennisPhotos.com

China links of the day:

• China move towards giving freer rein to the yuan.
• China’s high-speed rail ambitions receives another setback as a section of a high-speed rail line collapses in Hubei province.
• BMW’s profits reach all time high thanks to demand from China.
• China’s trade deficit raises concerns.
• The World Bank releases a report called “China 2030: Building a Modern, Harmonious, and Creative High-Income Society” which highlights risks that the Chinese economy will face and urges China to consider major reforms.
• Chinese government working on easing inflation.

I am not normally one to attribute rhyme or reason to the movements of stock market indexes. In most cases, only a fool would say how a market is going to move on any given day. Yet today, with the news from China’s central government that it would encourage its domestic market to invest and consume more, it appears to have moved markets in a straight-forward correlation. Certainly, Chinese investors have come to expect the government to step in to prop up stock markets. Last week, it was a rumored $50 billion ‘buffer fund’ that prompted China investors to rally.

US investors are not so easy to impress. The Chinese spending package was not enough to dent the malaise over the US markets, which today were hit by the new of the bankruptcy filing of a major electronics retailer, Circuit City, and layoffs at the US subsidiary of DHL. Finally, the spectre of a slew of possibly negative economic data to be released later this week, including the trade balance, may be prompting caution.

But, back to China, the relatively huge gains in China and other Asian markets indicates, to me at least, that China’s economic news does have the power to help stimulate regional stock markets. But will the package, as China’s leaders claimed, actually help stabilize the world economy? Put another way, can China’s economy save the world’s?

To elaborate on that point, one must not imagine that China will quickly start spending its half trillion dollars to ramp up imports, thereby helping its trading partners. The main effects of this package will be to further push China’s economy toward domestically-fueled expansion via consumption and investment.  It is China’s biggest package ever, the equivalent a $2 trillion package for the US economy, but it will do little to help the world economy, other than encouraging a stable China.

China can afford the package without running a huge deficit, but is there any other cost? Inflation, possibly. One thing is clear, China is most definately now a Keynesian. I hope it can avoid the fate of Japan of the 90s, which tried, and is still trying, to spend its way out of the economic doldrums. Nobody wants to see another lost decade.

China Supertrends has been following the financial implications of the sub-prime crisis for a while now and will comment on this latest development and the state of China’s stock markets in a separate post. Today, Tuesday, September 16, was yet another blood-bath in the markets, but at a time like this it is worth remembering that China’s underlying economic fundamentals remain very strong.

In fact, China just came off yet another strong month of growth. If this is true, what causes the apparent contradiction of one of the world’s best performing economies having one of the worst-performing stock markets?

In brief answer to this complex question, let’s just say that the theory of decoupling – the idea that China and other developing countries are mature enough to continue to develop on their own during an economic decline in the US and elsewhere – is increasingly discredited.  We wrote as much in Supertrends: We are living in an inter-connected world, and nothing, not even neo-Mercantilist policies, a protected currency, nor the world’s largest foreign reserves, can resist the forces that are sweeping our world.  As John Donne famously said, no man is an island. This financial crisis calls to all governments to act.

China, with its strong economic performance in August and year-to-date, may appear to be in the eye of the storm, an island of calm and prosperity. Last week was the Mid-Autumn Festival, and the economists at China’s National Bureau of Statistics were producing new data faster than mooncakes at Wang Jia Sha. Virtually everything seems according to plan.

Starting with the drivers of the economy, consumption continued to show signs of strength, with retail sales maintaining a 23.2 percent pace of growth in August, only slightly lower than July’s 23.3 percent, the fastest rate since 1996, according to the Shanghai Daily.

The level of retail sales growth is far above the most recent inflation levels, meaning retail sales growth is not just about price increases, there is real growth there.  In fact, CPI – the consumer price index, or basic inflation – decreased to 4.9 percent in August, continuing the downward trend, but worrisome PPI – the prices producers are paying for raw materials and commodities – continued to climb, to 10.1 percent in August. PPI increases will, at some point, either result in decreased margins and profits as companies absorb the increases, or get passed on to consumers as price increases, so China is not out of inflationary woods yet.

Many were regarding the fight on inflation to be one of China’s core economic policies of 2008, but in a surprise move today the People’s Bank of China decided to cut interest rates by about a quarter percent, down from 7.47 percent to 7.2 percent and, in perhaps the most surprising move of all, cut the reserve ratio by a full one percent after having just increased it by one percent in June.  Now that the Olympics are over, micromanagement of the economy seems back in style.

But the message, that the economy is ready for a rate cut and wants to increase money supply, could be evidence that the PBOC overshot the mark and caused money supply to shrink too quickly, contributing to some of the summer’s abysmal stock and real estate performance.  Growth in M2, the money supply, decreased to 16 percent in August, down from 17.4 percent in June.  It is important to point out here that we are still talking about an increase of 16 percent, just that the rate of speed it was growing simply slowed down a little.

Is the PBOC acting wisely or foolishly? Time will tell if they are cutting too soon, a knee-jerk reaction to the latest sub-prime casualties, trying to prop up the falling stock and property markets, or if they are presciently avoiding a much harder crash in the wake of Fannie/Freddie/Lehman fallout and other factors yet to come.

While some of this data could be construed as negative, China had a lot of other positive economic results in August. For example, the trade surplus is up by 25.7 percent year-to-date, compared with Jan – Aug 2007 figures.

In August, with industrial output growth the lowest in 18 months, a mere 12.8 percent increase, exports decreased to 21.1 percent from 26.9 percent in July. Imports were down more dramatically, from 33.7 to 23.1 percent, mostly because of commodity import price decreases  (i.e. oil), so the trade surplus actually still got bigger.

Though slowing its rate of increase slightly, clearly China’s export prowess is not affected significantly by the world-wide financial crises, and despite the 2008 increase in  the strength of the RMB exporters seem to have adapted. The sky, it woud seem, is not falling, though its perhaps a paler shade of grey. Ecnomists, analysts, and the Chinese media make a lot of dire proclamations about how the Chinese economy is in decline but this is better thought of as healthier, sustainable growth.

I could go on. FDI and other investments – still strong. Foreign reserve size- still troubling, but thanks to the Fannie Mae / Freddie Mac bailout, the 20 percent of reserves held in US mortgage debt appears safe.

So the question originally posed, why is there a contradiction? China’s strong economy (with all the usual provisos and assumptions about the data, of course) on the one hand, and its weak stock and property markets on the other. What gives?

Is this a sign that global markets cannot decouple and are doomed to falter together, or is it a sign that somebody needs to act more decisively?  Just as China became a stabilizing force in the Asian Financial Crisis of 1997, is there are way it could use its economic and financial strength to do so again?

No country is an island in our globalized world.  Everybody has a stake.  With the alarm bells sounding, can China passively wait for the U.S. to get through its bailouts, and hope that the world financial system remains intact?  Or does this bell ring for another?  Whom does the bell toll for?  China, it tolls for thee.

Here at China Supertrends, foreign reserves and hot money are an endless curiosity, having achieved in China never-before-seen volumes, anywhere, in the history of mankind (Perhaps the Romans had a proportionally large foreign reserve, but should that count?).

In a July 3 report from Xinhua, a SAFE official appears to have confirmed the much-speculated figure of US$1.797 trillion in foreign reserves as of the end of May, increasing about US$115 billion in just two months from the last officially-released figure of US$1.682 trillion. From the Xinhua article:

During the first five months of 2008, forex reserves increased by 18.7 percent year-on-year, or US$268.7 billion, SAFE figures showed.

As Brad Setser mentioned recently (and in this older post), there is likely an under-stating of the true amount of the increase in foreign reserves due to internal transfers to the state investment funds Hujin / China Investment Corporation; Chinese banks holding more foreign reserves as the reserve ratio continues to increase (up an additional one percent in June to reach 17.5 percent at present); and revaluations of China’s non-US currency holdings. As well, I’d point out the significant amounts of capital entering the market via the Hong Kong / Shenzhen corridor’s frequent travelers, black market currency traders throughout China, and people such as the Atlantic’s James Fallows withdrawing as much RMB from their foreign bank account as the limits will allow.

Back to the July 2 press release from SAFE, a Financial Times story on July 2 translates some important details:

Exporters will now be required to provide documentary evidence that their invoices are based on genuine transactions if they wish to change dollars into renminbi. The regulator said the new computer system for checking invoices would be introduced on August 4. A trial period begins on July 14.

This is serious news for exporters, and will create additional paperwork and possibly delays for many legitimate transactions. Still, this is what the hot money problem has come to: Reserve ratio increases can soak up liquidity but this is merely treating the symptoms rather than curing the disease.

If the trial proves feasible (and considering the volume of trade, it may not) this will be another problem, in addition to the rise in transportation costs, for China’s exporters (foreign and domestic companies alike) and possibly cause export growth to slow. Not good news for trade, perhaps, but a step in the right direction to reduce hot money.

UPDATE JULY 4: From the Wishful Thinking department, CBS MarketWatch reports SAFE has “limited” foreign tourists to exchanging a maximum of US$50,000 during their stay for the Olympics from July 8 to October 17:

The regulator said the quota would provide tourists with enough spending money while also helping to limit foreign exchange inflows during the games.

With an estimated 500,000 foreign visitors (that’s assuming they can get visas), what’s another US$25 billion of foreign exchange between friends?

Related information:

h/t to China Herald for the excellent Olympic-related news coverage.

An article from Reuters on the foreign exchange issue, relating to the previously-unofficial May 2008 increase.

Retail in China can be a mixed bag: French-retailer Carrefour may be having problems, but China’s Lianhua is doing well, and foreign firms such as Staples and UPS are expanding, even as Bertlesmann China closes its retail outlets.

There are clearly winners and losers, but retail consumption overall is the most important driver of growth in the Chinese economy. The picture is bright, according to a report by AT Kearney that ranks China as the fourth most attractive retail market (h/t to China Law Blog).

Here is my article from the June 30 edition of the Shanghai Star Business Journal, with some before and after pictures for your enjoyment.

__________________

As world energy prices begin to affect transportation costs, the appreciating yuan results in a decreased demand for Chinese exports, and a tighter monetary policy starts to reign in inflation, the question now is how China will avoid a dramatic economic slowdown. If Shanghai’s Wujiang Road area is any indication, retail may be the answer to China’s excess supply, with China’s newly-affluent middle-class consumers increasingly demanding more.

People who have been living in Shanghai for longer than three years will have distinctive memories of the old Wujiang Road, the bustling restaurant street running parallel to Nanjing West Road near the subway station and intersection of Shimen No. 1 Road.

The area directly behind the station used to have Chinese eateries and snack stands, push-cart vendors and colorful events such as a weekly English corner. Now, in much the same way the Huangpu River separates Puxi from Pudong, old from new, Wujiang Road stands divided: East of Shimen No. 1 Road, the street remains much as it has always been, while the western half has recently taken on a new look: Redesigned by Singapore’s Frasers Property and rebranded as InPoint, part of the Jing’An Four Seasons mixed-use residential and retail development, western Wujiang Road is home to a newly-renovated shopping arcade.

The loss of yet another part of Shanghai’s historic past aside, it is hard to deny the new layout and selection is vastly improved.

Where once were about twenty small restaurants and shops now stands a mall with space for more than ninety. Hole-in-the-wall bubble-tea stands have been replaced by four coffee chains including the ubiquitous Starbucks. What once was a Chinese snack vendor selling meihuagao (a rare and delicious baked rice cake with red bean paste inside and topped with dried fruit) is now an Iceason. If you don’t like their ice cream, you can go to one of three other frozen dessert shops, such as a DQ and Cold Stone Creamery, or try Honeymoon Dessert, one of the many Hong Kong and Taiwanese-style snack shops.

Much like the Wujiang Road of old, there are sit-down restaurants galore, but now with a corporate-branded flavor. And that’s not even mentioning the shops: Retailers Levi’s, Tissot, and ONLY, and other sellers of everything from stuffed animals and puzzles to jewelry and baubles.

All this stands in stark contrast to the eastern side of Wujiang Road, with its low-priced stinky tofu vendors, fried dumpling shops, and outdoor crawfish restaurants.

In fact, the transformation of Wujiang Road is not unique, and is merely symbolic of how retail is quickly maturing in China. Shanghai has dozens of revitalized or new shopping areas taking shape, and it seems there is now an international-style mall on every major street to replace what once was a local- or state-owned retailer.

Nationwide, China is home to four of the world’s fifteen largest shopping malls, but many of them, including the world’s biggest in Dongguan, Guangdong Province, are having trouble filling up the space. This begs the retail supply question: If you build it, will they come?

Retail spending has been growing rapidly in China. In 2008, urban retail spending is up 22.3 percent in May year on year, with an average rate of 21.1 percent this year so far compared to the same period last year, according to China’s National Bureau of Statistics. This growth seems likely to exceed 2007′s 17 percent overall increase in retail spending, but this is partly expected due to the increased inflation rate compared to 2007. However, by taking inflation out of the calculation, real retail spending has still grown 13 percent in the first quarter of 2008, according to the World Bank’s most recent China Quarterly Update.

Another important indicator is that in 2007, China’s consumption growth – the portion of GDP growth that covers all the goods and services consumed by households – exceeded the growth due to trade or investment to become the top driver of China’s economy, albeit by a slim margin.

Of course, retail spending is only a part of total consumption, but it is a growing part in China as disposable incomes go up. In 2007, average urban salaries increased 18.7 percent, according to NBS figures, nearly four times the 4.8 percent pace of inflation in 2007, and minimum wage levels were increased in many of China’s largest cities. This excess income will drive new retail spending.

Short-term economic statistics aside, where will the long-term support for retail growth come from? There are three major population segments that will keep retail spending high in China’s cities: The white-collar youth, newly-urbanized migrant populations, and the nouveau riche who are spending on big ticket items in the automotive, housing, and luxury markets.

One study by MasterCard estimates that China will have more than 117 million young people with a yearly income greater than US$60,000 by 2016. A recent survey by website zhaopin.com of 6000 urban Shanghainese white-collar workers found that 80 percent had credit cards, and more than half of them already considered themselves in hock to their cards as monthly “card slaves.” The spending power of more than one hundred million high-income consumers who are comfortable with credit card debt, many of whom will live at home until marriage, will be of growing significance to retail sales.

Second, the urbanization trend in China shows no sign of slowing down. The McKinsey Global Institute estimates China will almost double its urban population to 926 million by 2025, with 219 cities of more than a million inhabitants. Each of these cities will have their own Wujiang Road-style pedestrian malls to stimulate consumers’ taste buds and empty their wallets.

Finally, China’s most affluent people, those who can afford their own cars and homes, are literally driving new trends to support their high-end consumption habits. Cars and homes create much related-goods spending, allowing auto-accessories stores such as Japan’s Autobacs, and home-furnishers such as Ikea, to prosper.

As well, the World Luxury Association reported that in 2007 China became the world’s second largest market for luxury goods such as watches, bags, and jewelry, and will top world leader Japan by 2015.

One only needs to look in a three block radius of the new Wujiang Road to see a healthy microcosm of China’s retail environment: Eastern Wujiang Road for the traditionally-minded, the new InPoint shopping street for young consumers, and Nanjing West Road’s high-end fashion and luxury retailers for the affluent. Some may miss the old meihuagao vendor, but China’s economy is not looking back.

Who wants to be a multi-trillionaire?

Based on the apparent pace of growth in China’s foreign reserves, the State Administration of Foreign Exchange may need to answer this question in a mere three months. Its answer should be an emphatic “Not China.”

In fact, SAFE’s next quarterly announcement of foreign reserves is not due until July but unconfirmed reports have been flying through state and foreign media (covering an unofficial number in China Business News interestingly) that China’s foreign exchange reserves increased by US$74.5 billion in the month of April alone, to reach US$1.76 trillion.

As a point of comparison, the world’s second largest foreign reserves are held by Japan, and in March 2008 they increased by one tenth of China’s apparent April gains – just US$7.6 billion. Incidentally, it was only in February that Japan’s foreign reserves surpassed one trillion for the first time, and they have since fallen back below the trillion mark, once again leaving China the lone member of the trillionaire’s club.

China first hit the one trillion mark way back in November 2006 but, unlike Japan, its foreign reserve increases are usually measured in double-digit billions. If later confirmed by SAFE, April’s increase of US$74.5 billion will be the biggest ever increase, anywhere.

If this pace continues, China’s foreign reserves could reach two trillion as early as August this year.

This is perhaps not the message China’s government wants to send to the world during the Beijing Olympics (“All your money are belong to us”), so there is intense discussion at the highest levels of China’s government over two issues: How to reduce the foreign exchange reserve, and how to use the existing foreign reserves more efficiently.

Reducing China’s Foreign Exchange Reserves

At one time, having enough money on hand to pay for imports might have been a prime consideration, but this has not been the case in China for years. Its current amount of reserves may cover monthly imports 15 times over, or more. What about another main reason countries keep a large foreign exchange reserve on hand, to defend the currency from speculative attack?

China does not allow convertibility of the yuan, which curtails the possibility of a run on the currency, but as well, China, together with the ASEAN countries plus Korea and Japan (the so-called ASEAN + 3), recently pushed forward the Chiang Mai Initiative, a US$80 billion foreign reserve pool that could be swapped to any member country experiencing speculative pressure. In theory, from 2009 this could reduce the need of Asian countries to hold such large foreign reserves. Until then, Asian central banks may feel better safe than sorry and decide to keep more reserves on hand, but China really doesn’t need to do this in the first place, so it needs to more aggressively reduce the size of its foreign currency holdings.

One way to reduce the size of the foreign reserve is to encourage foreign currency outflow. At present, the yuan’s continued and still expected appreciation has actually increased inflows, both as FDI and as hot money, to record levels.

In the first four months of 2008, FDI was up almost 60 percent over the same period last year, while the total number of company registrations actually decreased by 23 percent, according to the Ministry of Commerce. One likely explanation for this is that foreign firms inflated their average investment size so as to benefit from the future yuan appreciation. In fact, for hedge funds and other investors, this is one of the only methods they have to skirt Beijing’s capital controls, sneaking money in as legitimate-seeming FDI. The exact amount of hot money is unclear but can be inferred from known inflows (e.g. announced FDI), the estimated trade surplus, and other data.

To lessen the inward flow of hot money, China could either reduce interest rates to make passive funds less profitable in China, or could revalue the yuan exchange rate in a one-off revaluation similar to 2005 when the original dollar peg was removed. The former is likely to exacerbate China’s current inflation problem, while the latter would shock the country’s exporters. On balance, allowing the yuan to appreciate faster seems the lesser of two evils for the government.

An appreciation will cause outflows for several reasons. Some of the hot money will repatriate, while the stronger Chinese currency will encourage more consumption and imports from abroad. If the trade balance can reverse the current trend of annual surpluses, foreign reserves will dwindle rapidly.

Using the Foreign Reserves more Effectively

The second issue on China’s leaders’ minds is how to use existing reserves more efficiently. Some may even wonder why large foreign reserves are a problem at all. A rich country is a strong country, as this argument goes.

But the foreign reserves are, in effect, sitting in the central bank earning meager returns and keeping the yuan under-valued. Each unit of foreign currency that enters China is bought up by SAFE and yuan notes are issued by the central bank.

China does not actually hold wads and wads of cash, like a high-roller hitting Macau’s new casinos. Most of its funds, especially those denominated in US dollars, are in the form of US Treasury bills and other long term securities. T-bills have a notoriously low interest rate because they are seen as the safest investment available.

With China holding an estimated US$466 billion in T-bills alone according to the US Treasury, earning interest in the low single digits, this means China is literally leaving billions in potential investment income on the table.

Couple this opportunity cost with the depreciation of the US dollar against major world currencies and China’s US dollar holdings are looking even less attractive. Given a common estimate that China’s total foreign reserves are comprised of about 70 percent dollar-denominated securities and cash, and that the depreciation in the US dollar over the last year has been about 10 percent against the yen and 13.5 against the Euro, that is like saying those Chinese reserves in US dollar terms have lost about US$100- 150 billion in spending power.

Of course, China’s Euro and Yen holdings have increased buying power in terms of US dollars, but they only represent about 20 percent and less than 10 percent respectively of China’s foreign reserves. With such low interest returns and the passive depreciation of its US dollar holdings, China is anxious to look for other ways to spend its growing fortune.

In the last six months, SAFE has made a number of portfolio investments abroad in an attempt to diversify and increase returns, while China created the China Investment Corporation, a US$200 billion sovereign wealth fund, in 2007 to place funds in higher-growth areas. [ED: I covered the uses of China's foreign reserves by both SAFE and CIC in an earlier post, The New Gold Mountain.]

At the time of writing, the yuan appreciation has reached 20% against the dollar since that fateful day in 2005 when the peg was finally removed. It has taken three years to get here, and if it takes three more for the next 20%, I worry about the effect this will have on inflation in China as the foreign reserve will continue to surge.

There’s no easy solution to China’s growing problems of inflation and low rate of return on its reserves, but letting the yuan appreciate more quickly is probably the best place to start, for the sake of the Chinese economy, and maybe even the global economy, as a whole.

[UPDATE: June 25 - Two notes which just came to my attention: In regard to how some foreign media have not covered the April 2008 rise of US$75 billion as alarming or even sufficiently surprising, Yves Smith of Naked Capitalism commented yesterday on the apparent nonchalance, and overnight Brad Setser added some data on changes in China's portfolio investments and overall foreign asset growth. On the point of western media attention: I don't think the lack of in-depth coverage on the ramifications is indicative of disinterest. As I pointed out above, the April foreign reserve figure of US$74.5 billion hasn't been officially confirmed and will not be until July, most likely. I held off reporting on this figure in my newspaper column until June 23 expecting a repudiation by SAFE or the PBOC, but their combined silence on this issue has been deafening.]