Sure the build-up of dollar reserves in the PRC could be a potent political weapon – but there necessities for them to keep high dollar reserves:
1. The Bank of China (PRC) is not transparent. No real statistics show how my Kiljillians of RMB have been printed. This knowledge to lead to a run on the Bank of China.
2. Interest rates are relatively low in the PRC. If one were to add inflation the interest rates would be paper thin. This leads Chinese investors to buy high quality US Bonds which pay better rates (and stocks high dividends paid in US dollars – say Hong Kong shares of Chinese companies and “B” shares of Chinese companies).
3. Some people in China can get very low interest loans. These loans facilitate the age old “Carry Trade.” This is when Chinese can borrow cheap money and buy high yielding US bonds pocketing the spread.
4. China buys most of its oil with US dollars and there is no end in sight for that.
5. China could possibly become “export un-competitive” if inflation, including wage inflation, were to get out of control – which it could.
6. The Chinese authorities have been raising interest rates to halt the over heated economy causing Chinese debt instruments to fall and causing investors to run to dollar instruments.
If China wanted to cure its inflation ills and overheated economy [1] they should let the Yuan float freely in the world currency market.
If they continue to tie the Yuan to the dollar they must print more Yuan which just increases the problem.
[1]
The central bank, in an effort to keep the yuan stable, buys most of the dollars generated by the surplus, for which it must in turn print yuan, thus flooding the banking system with cash.
Gao Shanwen, chief economist at Everbright Securities in Shanghai, said he thought the interest rate rise would only exacerbate that problem.
“Higher interest rate rises can help slow down investment and domestic consumption. With domestic consumption weakening, more and more goods would have no market at home and have to be exported abroad, which would make the trade surplus even larger,” Gao said.
See: China raises interest rates again to cool economy
http://www.iht.com/articles/2007/03/17/business/yuan.php
