China's forex weaker than perceived

Analysts suspect China's forex may be weaker than perceived. This article is waste of time because not only is there no new information, the conclusion is wrong. The most important piece of "news" is that China's forex is used to defend the currency. China can improve its financial position and strengthen or weaken the yuan depending on its mix of assets, but the immediate effect of spending the reserves is to weaken the currency. If, and that is a big if, those proceeds are used in a way that increases demand for the currency, then it can lead to increased demand for the yuan. However, since China still maintains a quasi-peg to the U.S. dollar, it needs dollars to defend the peg. If for any reason Chinese stopped repatriating yuan and chose to hold dollars, or went to the bank to exchange yuan for dollars and the central bank did not have enough dollars, the supposedly strong yuan becomes the Thai baht of 1997. China's monetary policy is to take export an earned dollar and swap it for Chinese yuan. If the central bank spends the yuan, then more yuan is unbacked. Until China decides to float the yuan, it still requires a large amount of forex to credibly back its yuan price.

The conclusion:
And it explains why foreign reserves cannot easily be used for domestic spending on infrastructure or shoring up pension systems, since simply converting the cash risks driving up both inflation and the value of the yuan currency.
Yes, it would drive up inflation via money printing (they handed out 6 yuan when they swapped the dollar for yuan, now they spend it again for 6 yuan, total 12 yuan per dollar), but government directed spending is no longer efficient. The low hanging fruit was picked and wasteful investments are piling up. Given the state of the global economy, the losses are more likely to show up, at which time some people may question the value of the yuan and switch to U.S. dollars. And note, if they spent all of their forex, then the yuan would likely fall, as one cannot print money at a rate of 12 yuan to 1 dollar and not expect the exchange rate to head in that direction.

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