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I could not agree with you more that keeping a hoard of dollars in the face of massive quantitative easing that dilutes the purchasing power of each dollar held in reserve, is a losing business proposition. Using these dollars to buy Yuans from the Chinese citizenry, however, only compounds the problem, instead of solves it. China gets now two problems instead of one.|
The new problem arising from selling dollars to buy Yuans is that the exchange rate of the Yuan becomes overvalued, making products of China's factories overpriced in dollars abroad and also overpriced in Yuans at home, leading to the current chain reaction of falling exports, contraction of manufacturing, rising unemployment, lowering of wages leading to labor strikes and unrest, falling foreign currency reserves (because of decreased exports coupled with increased sale of dollars for yuans). The offshoot of lowering of wages and rising unemployment is that fewer people are buying new homes, leading to a contraction of the housing market. The contraction of the housing market is now forcing the middle and upper class to put their money in the stock market, and also in the loan-sharking market, both of which reinforce each other when buying on margin is allowed loosely for the general public, leading to the stock market bubble we just saw deflating in the past 3 weeks.
You may ask, well, how then can China spend all its 3.7 trillion dollars of foreign currency reserves?
That is not really a lot of money, if you consider that the funds being managed by major brokerages around the world are at least worth one trillion dollars each. If China wants a conservative portfolio, it merely has to follow the footsteps of Warren Buffett, whose dictum is that investment is most intelligent when it is most business-like, meaning, the firm whose shares are to be bought must be a profitable business to begin with, and that its earnings divided by its market price must be double the prevailing prime rate of the country it is located in. The next principle is that the amount invested in any one company must not cause the price of the shares to go up, forcing one to keep buying it at ever higher prices until one's order is finally completed. This is a real possibility considering the amount of money that China has. And the last principle is that the amount invested in any one company must not exceed 1% of the total capital, and thus if the total capital of foreign currency reserves minus foreign-currency-denominated loans and liabilities is equal to 1 trillion dollars (I doubt it is this high even), then 1% would be 10 billion dollars (hardly any company would be worth that much investment though). First of all, China's total foreign-currency-denominated loans owed to foreign creditors is probably near 3 trillion dollars by now, so the best use of the "surplus" foreign currency reserve of the PBOC is to pay off these loans, which gets rid of its surplus dollars overnight. The leftovers would be one trillion dollars at the most, not a huge sum for a sovereign country to possess or to invest.
By simply not buying yuans with its reserve dollars, the Yuan exchange rate would come down naturally to around 6.50 Yuan/Dollar, and immediately within 3 months, China's exports would be rising, its employment rate would go up, its foreign currency reserves would go up, and normal investment in real estate by new buyers would go up as well. The pressure on the public to invest in the stock market would go down, and the stock bubble will not form. Any further accumulations of foreign currency can be used to buy mineral resources and profitable businesses abroad, and when nothing is worth buying because they are overpriced, then gold would be cheap in comparison and worth buying more of.