Are Falling Reserves a Problem?

04/17/2015 12:01 am EST

Focus: GLOBAL

Jim Jubak

Founder and Editor, JubakPicks.com

Even though the Shanghai Composite is at its highest level since 2008, MoneyShow's Jim Jubak is concerned China has continued to use their reserves in order to defend their currency.

It's tempting to think of China as an exception to almost every economic and financial markets rule. You've got an economy slowing and, yet, the Shanghai market has broken through levels that it hasn't seen since 2008.

But it's not.

Right now, we've got a lot of worry around emerging markets because we're seeing money flow out of them.

The numbers from China released for the first quarter around April 10 say, hey, we're seeing a big drawdown on Chinese foreign exchange reserves, that, in the last quarter, we saw about $113 billion flow out of those reserves, drawn down to pay for something, and we'll talk about what that something is later.

This is the third consecutive quarter where China has drawn down on reserves.

We're talking about reserves that were once above $4 trillion, now down to about $3.7 trillion.

Certainly, China is not in any danger of going bankrupt, but the pattern is a disconcerting one because this is one of the strongest of the emerging market economies, this is the strongest foreign exchange reserves, really, in the world.

So this pattern for China has mad implications for other countries that aren't in as good of shape. What's going on here is that the Peoples Bank of China is spending its reserves to defend the yuan-renminbi that, as the dollar rises, the renminbi is in danger of falling.

You, sort of, say, “Well, in countries like Japan and the EuroZone, they're interested in having their currencies fall.”

Well, China is not, because the sort of domestic repercussions of that are so large that, if the currency was to fall, the prices for things like imported food, imported goods like shoes, whatever it is that the Chinese consumer would be importing, that would go up. That would cause unrest. You've got a lot of Chinese companies that have dollar denominated debt. If the yuan fell against the dollar, that debt gets more expensive to pay back and that's not what Chinese companies need at this point. Chinese companies are trying to be in an acquisition mode in sectors.

Again, if the currency falls against the dollar, those acquisitions get more expensive and, of course, there's always just the possibility that, at some point, someone says, “Oh, this is not just a short-term trend, this is a long-term trend,” and then the decline in the yuan-renminbi speeds up and that's the last thing that Peoples Bank wants, so big, big drawdowns on foreign exchange reserves to defend the currency.

No danger of China running out of reserves in any foreseeable future, but I think this is an indication of exactly how the strong dollar around the world in one emerging market or another affects even the strongest of the emerging markets.

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