China’s foreign exchange reserves assets are in great danger!

 Ben Bernanke said on Wednesday that the QE3 might be on the Table. “The possibility remains that the recent economic weakness may prove more persistent than expected and that deflationary risks might re-emerge, implying a need for additional policy support,” Ben Bernanke, Fed chairman, told the House of Representatives Financial Services Committee.

His words were generally seen as a signal of a possible QE3 (quantitative easing), which analysts said may add to China’s inflation and endanger China’s $3.2 trillion foreign exchange reserves.

But on Thursday, Ben Bernanke told Congress the central bank actually isn’t prepared to take immediate steps to boost the economy. “We are not prepared at this point to take further action,” Bernanke said at a Senate Banking Committee hearing.

Whether or not the Bernanke will push out QE3, China’s foreign exchange reserves are in great danger.

Almost two thirds of Chinese foreign exchange reserve is investing in US dollar denominating assets, and Chinese central bank now holds over USD 1.3-1.5 trillion U.S. government bonds. China is the largest overseas creditor to U.S. government.

Quantitative easing (QE) policies means the Fed printing a lot of US dollars and put it into the world market through the purchase of U.S. government bonds. Fed’s action would result in the depreciation of U.S dollars and causing the inflation in lot of countries, including China. Both the inflation and the US dollar deprecation will definitely hurt the interest of U.S. government’s creditors. The real value of U.S. government bonds will shrink significantly and Chinese government will suffer a huge capital loss. If US dollar depreciated again RMB for 20%, Chinese central bank will suffer a USD 390 billion capital loss, almost 8% of China’s GDP in 2010.

Chinese government is now facing a dilemma on how to deal with the huge amount of the foreign exchange reserve assets. One possible solution is to diversify its investment portfolios of foreign exchange reserve, such as investing in euro assets.

Europe could be one of the suitable places for investment; its market could contain a large amount of money. Besides, Euro remains much more stable contrasted to U.S. dollars. So, in some way, cooperation with Europe was a good choice to China. But now, it is not that optimistic. The situation in the euro area has not changed much and the debt crisis did not ease. In this Tuesday, Moody downgraded Ireland to junk status, fueling concern that the European sovereign-debt crisis will spread and dampen investors ’appetite for higher-risk assets. So, Europe is not a safe place for china’s to invest its foreign reserves. Besides euro area, there is no such a big market to contain China’s huge scale of foreign reserves.

Though pessimistic, there is hope. China still has other solutions. Lian Pin, an economist from Jiaotong Bank in China, said that Chinese government could purchase more gold, energy, commodities, equities and corporate bonds, decreasing the over reliance on government bonds. Besides, moderate appreciation of RMB and maintaining a reasonable deposit and lending rates is also a secure countermeasure.

Peng Bo is an editor and author of M4.cn, write to him at pb.bloomberg@gmail.com.

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