Why China should stop piling up dollars (and why it won’t)

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In today’s FT, Martin Wolf writes about China’s $2.1 trillion in foreign currency reserves:

It is little wonder such a huge exposure makes the Chinese government nervous. But nobody asked the Chinese to do this. On the contrary, US policymakers have consistently (and wisely) advised them to do the opposite. Having made what I believe was a huge mistake, the Chinese government cannot expect anybody to save them from its consequences.

A substantial appreciation of the Chinese currency is inevitable and desirable in the years ahead. The longer the Chinese authorities fight it, the bigger their losses (and the pain of adjustment) are going to be. What they have to do is cut those losses, by ceasing to accumulate yet more reserves.

This is a point worth reiterating. Every time a Chinese official expresses worries about the safety of that $2.1 trillion (the bulk of which is held in dollars), the U.S. financial media broadcasts the news as if it is a horrible and frightening prospect. But in fact acting on those worries (by allowing the yuan to appreciate against the dollar) is exactly what we want China to do. What’s keeping it from happening is extreme suspicion in China of such a course. It is an article of faith within the Chinese business community that Japan’s lost decade in the 1990s was the direct result of acceding to pressure from Washington to allow the yen to appreciate against the dollar. So it seems like any external attempt to pressure China into stopping with the dollar hoarding—which is what a lot of the G-20 crowd seems interested in doing this week—is going to run into an awful lot of resistance.