Bill Gates and China…

China’s wealth of reserves is massive, impressive.  Some analysts estimate the value of China’s foreign reserves to be in near $2 trillion (with about a trillion of that in US treasuries).  Yes, China has way more wealth than Bill Gates ….so where is the connection?   Hang on, I’ll get there, but first…lets look at the data from Brad Setser blog:

In 2008, my best estimate  is that China bought $374.6 billion of the $1684.8 billion increase in the outstanding stock of marketable Treasuries not held by the Fed.

China currently has — in my judgment — about $900 billion of Treasuries.

Wow!  That is an incredible amount of money…But its not money that China has…no,actually… its mostly money that is owed to China.   Money being lent from China to the United States.  In this upside-down world of international finance, we actually see money flowing from places like China on a massive scale to countries like the USA… (note that only in recent history is money borrowed by rich countries from developing ones!).

But, having a massive amount of “reserves” (on paper) makes China rich, no?

On paper, yes…But, remember…these reserves (in the form of US treasuries) are like I.O.U.’s from the US to China.   In other words, the US takes the money now, and issues I.O.U’s for future payments, which fill up the Chinese reserves… As a result, this massive “wealth” of foreign reserves is a bit illusionary…because it exists on paper, and not in physical wealth.  (the real wealth of China* lies in its stock of productive capacity and innovative people…. and not in its paper wealth of international reserves)….

There are three main problems with a “wealth” of reserves…

  • Much of it is paper wealth…. its like Bill Gates having been the richest man, but having had all of his wealth tied up in MS stock…if he had tried to cash out quickly, it would have driven the stock price down…eliminating much of his paper wealth. China is in a similar situation; having the wealth of reserves tied up in I.O.U’s (debt issued by the US)…if China were to suddenly try to sell their position in US treasuries, it would drive down the price and reduce their value.  So, much like Bill Gates, China would need to sell off its position gradually (or just slow down their pace of acquisition).
  • If the US dollar were to depreciate, the amount of “wealth” would simply disappear.
  • China cant spend that money internally without risking (a) inflation, and (b) currency appreciation. While inflation isn’t that big of a risk (now), the currency appreciation is. Remember…the only way china can run HUGE current account deficits is if they also simultaneously run capital account surpluses (the Balance of payments must balance). So, that surplus capital must exit the country, or else…if they spend it internally, the current account must shrink (What would be the mechanism by which this would happen?… currency appreciation to eliminate exports).

Can China spend this “wealth” on Fiscal Stimulus?

No, I dont think so.

Its not that they dont want to (I believe the Chinese would love to spend that money to stimulate internal demand and boost production / jobs).  It’s that they can’t (at least not easily, and not all at once).

But, you might wonder…didnt I just read about a massive fiscal stimulus package coming from China?  Yes, you probably did (we highlight this in our wiki).  But, much of $600 billion in fiscal stimulus that China announced in (late) 2008 was already-planned spending (see Heritage Foundation analysis here).

Foreign analysts that encourage China to spend that stockpile of “money” to stimulate the internal demand (and boost the world economy) are likely to be disappointed.

*The Chinese wealth ultimately lies not with stockpiles of foreign reserves but in developing and expanding their internal market.  Stimulating demand internally and becoming less reliant on export growth is the key to China’s bright future. Put your comments in our forum here:  Stockpile of US dollars — how should China invest?

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Originally published at Globo Trends and reproduced here with the author’s permission.

5 Responses to "Bill Gates and China…"

  1. Guest   January 29, 2009 at 7:09 pm

    By “stock of productive capacity” do you mean mothballed factories?

  2. Anonymous   January 29, 2009 at 9:26 pm

    If the US government is to go bankrupt anytime soon it would spell a head load of trouble for the DMCA. The EU has been itching to breakup Microsoft for a while now, and many countries will simply pirate software without accountability. The US government is the only wedge between a breakup or collapse of Microsoft and the rest of the world.

  3. Guest   January 30, 2009 at 4:18 am

    THE CONCEPT OF REAL WEALTH USED IN SMITH’S WEALTH OF NATIONS REFERS TO PRODUCTIVE CAPACITY. GERMANY LOST MUCH OF ITS PRODUCTIVE CAPACITY DURING WWII, SO THERE WAS DESTRUCTION OF WEALTH. THE MARSHALL PLAN REBUILT IT, SO THERE WAS CREATION OF WEALTH. OIL AND GOLD RESERVES DO NOT DEFINE A NATION’S PRODUCTIVE CAPACITY. SAUDI ARABIA IS NOT WEALTHIER THAN THE U.S BECAUSE IT DOES NOT HAVE GREATER PRODUCTIVE CAPACITY.

  4. Guest   January 30, 2009 at 5:06 am

    The ever wage and demand decreasing – global push for productivity (lower wages and indentured workers) cannot be escaped the ordinary person is doomed in the future to be slaves in a third world, world.

  5. Guest   August 4, 2009 at 4:02 am

    fdgfdgfdgfff