China's economic "paradoxes" and their solutions

08:15, December 31, 2010      

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As China becomes a major global economic powerhouse, the following paradox-like phenomena also seem to become more apparent.

They range from the huge foreign reserves it has versus the huge foreign investment it attracts, the robust exports versus the sluggish domestic demand, to the rapid economic growth versus the growing environmental concerns,-- almost all speaking to the complexity of China's interaction with the world.

Now the question is: Are these really paradoxes and what would be the solutions if they are?

FOREIGN RESERVES VS. FOREIGN INVESTMENT

According to official figures, by September 2010, China held 2.6483 trillion U.S. dollars in foreign reserves, of which about 907 billion dollars were invested in U.S. treasury bonds. Meanwhile, China has cumulatively attracted 1.06 trillion dollars in foreign direct investment (FDI).

Many perhaps will ask: Since China has such huge foreign reserves, why do we have to attract FDI with preferential terms rather than just utilize the reserves in domestic development?

The answer is rather "we couldn't" than "wouldn't."

Foreign reserves, in a broader sense, include foreign exchange, gold, special drawing rights (SDRs) and the International Monetary Fund (IMF) reserve positions.

These are assets of the central bank in different reserve currencies, mostly in U.S. dollar.

They reflect a country's international solvency power and are often used to import, invest, pay foreign debts, stabilize currency and defend against speculative attacks. They are generally not supposed to be circulated in the domestic market though readily available.

Zhang Bin, an economist with the Chinese Academy of Social Sciences, said if foreign reserves, after being exchanged by the central bank through printing domestic currency, were circulated domestically, they would cause an expansion in the amount of domestic currency in circulation, and hence cause inflation and affect monetary policy.


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