When $4 Trillion Is Too Much And $3 Trillion Is Not Enough

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News that China's reserves approached $3 trillion at the end of the last year has spurred expressions of concern. Its reserves have fallen by roughly $1 trillion since peaking mid-2014. The irony that is lost on many investors is two years ago pundits were arguing that China had too many reserves and now some are claiming that their reserves are insufficient.  

Insufficient for what? By most measures, they are more than adequate. The reserves are sufficient to cover imports for 18 months.The reserves are three times more than the short-term foreign debt obligations.China's reserves are insufficient if the current pace of drawdown continues.  

The value of China's reserves fell by $832 bln in 2015-2016. At the current pace of reserve loss, in three and half years, China will not have any reserves.Of course, this is not going to happen. The IMF argues China's reserves are "adequate" provide capital controls remain. Those capital controls not only remain, but they have been expanded.   

Some observers argue that the decline in China's reserves is equivalent to the amount of Treasuries it is selling. This is simply not true. China does appear to be reducing its Treasury holdings, but now where near the scale that has been suggested. According to the US Treasury data, China's holdings of US Treasuries peaking in late 2013 near $1.32 trillion.As of the end of October, which is the most recent data available, US Treasury estimates China's holdings of US government debt stands at about $1.12 trillion.  

The pace appears to have picked up in recent months. Of the roughly $200 bln decline in China's Treasury holdings, $125 bln took place since the end of May 2016.The change in bond prices probably had a limited impact over this period. Specifically, in June and July, the US 10-year yield, for example, fell 39 bp, but then rose almost as much in the August through October period.  

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