The NYT had an interesting piece this morning about possible plans by China's central bank to diversify its massive holdings out of U.S. treasury bonds in order to get a better rate of return. At one point it tells readers that developing countries have built up huge reserves in order to keep down the value of their currencies, which makes their exports cheaper. This is part of the story. The other big reason is that developing countries, like those in East Asia and Latin America, have found dealing with the IMF to be an extremely unpleasant experience. Following the East Asian financial crisis, and subsequent financial crises in Brazil and Argentina, many developing countries sought to build up sufficient reserves so that they need never deal with the IMF again. Some countries, like Argentina, even prepaid loans, so that they would not have to answer to the IMF. The way things stand now, the IMF is irrelevant for most middle income developing countries. The build-up of large reserves is a big reason. There is another serious oversight in this article. It raises the issue of the returns that China's central bank gets on its reserves. It reports that the return on the holdings in the U.S. are 4 percent (nominal). Actually, the returns would be considerably less. The interest on U.S. bonds and bills would be in the neighborhood of 4.0 percent (actually, they might be closer to 5 percent at present), but the dollar was been falling against the yuan. Even the very modest decline of the dollar over the last year and a half (@4 percent) would largely offset the return in dollars. This point is important, because the decline in the dollar was anticipated, it is actually deliberate policy by China's central bank. Clearly China's central bank is not buying dollars for the return, it is buying them to keep down the value of the yuan and sustain the growth of China's export market. It has been prepared to accept an extremely small or even negative return to accomplish this goal.
--Dean Baker
