Sometimes riches don't always lead to happiness. As the news about China's massive amount of foreign currency reserves hits the presses this weekend, peeved U.S. economists are banging louder than ever on the country's door.

The latest data show that China's foreign currency holdings rose to over $818 billion at the end of 2005. For China, this is partially good news. Reserves have their purpose: with so many Americans changing in their dollars for yuan to invest in local Chinese operations, the country needs to be ready to change yuan back into dollars in the event that investors want to pay dividends or pull their money out. Having too thin of a greenback cushion could lead to bank runs.

The problem is that $818 billion is hardly thin. The CATO institute, a D.C.-based research institution estimates that only a mere $100 billion would be needed to ward off a speculative attack. China's excess propped it up to #2 on the "biggest pile of reserves" list behind Japan, and the country now wields significant power over U.S. monetary policy. (The U.S. can keep interest rates low because China keeps buying our Treasurys.)

Having this gluttony of riches stripped naked for the whole world to see has been really annoying for the world's fastest growing economy. The U.S. and other nations have already done their fair share of nagging for China to revalue the yuan, which is now pegged at what economists say is an artificially low level. They've also been complaining about China's capital controls, which restrict how many dollars local companies can buy to invest overseas. Similar to how one feels worse saying no to the homeless guy on the street when she's wearing a fur coat vs. a ratty sweatshirt, China now feels increased pressure to yield to outsiders' requests.

The big question will be, does the pressure really matter? Yes, the Americans will have more weight behind their argument that China won't fall apart if they loosen their controls up a bit. But they wouldn't have fallen apart when they had $700 billion in reserves last October, or over $600 billion in 2004. So really, what's changed?

In this economist's opinion, it doesn't really matter what the data have revealed. If China thinks it makes sense to change its ways it'll do it: fur coat or not.

Posted by Michelle Smith on January 16, 2006 05:51 PM