COMMENTARY

------By Daniel Inman

There are many countries that would see having too much money in the bank as not being a problem at all. China, on the other hand, is in the rather unusual situation of having more money in foreign exchange reserves than it knows what to do with. In January 2007 it was announced that China's forex reserves were worth more than US$1 trillion, around a fifth of the world's total.

This gargantuan sum of money was acquired in a relatively short period of time. In 2000, China's foreign reserves were a fifth what they are now, and in the last two years they have doubled to their current amount, allowing China to overtake Japan as the country with the largest stack of foreign cash. The recent surge in foreign reserves corresponds to the increase in foreign direct investment and there is also plenty of money coming into China as people speculate over whether or not the RMB is going to rise in value.

Surely having plenty of money can only be a good thing. It can help soften the bite of an economic slowdown, providing a cushion for when foreign money stops coming in. But China's reserves already far exceed what is necessary to provide an adequate safety net. One trillion dollars would cover China's current level of imports for 15 months, and the amount far exceeds the country's short-term debt. There would have to be a crash of monumental proportions to eat through so much money.

There are a number of reasons why so much cash can be a negative thing. Fast-growing reserves can be symptomatic of an overheating economy, and banks flush with cash are more likely to be careless when lending money, thus driving up bad debts in the system. It is estimated that around 70 percent of China's reserves are in US dollars, which means that a large chunk of China's wealth is dependent on the health of another country's currency: a downturn in the dollar could cause big losses in China.

A trillion ways to spend a buck

If China decides that it does have too much foreign money in reserve, it will have to confront the problem of how best to handle so much cash for the overall health of the economy. And if it is a problem now, it will become an even greater one as it continues to accumulate cash: if China keeps on acquiring foreign currency at the present rate, it will have another trillion to deal with by the end of the decade.

Finding an alternative to storing money in foreign reserves is initially an attractive option. It would allow for some of the pre-existing reserves to be offloaded elsewhere, and present another destination for the money that has still to come into China. There is not one easy option though, because the process of spending even a fraction of a trillion dollars will inevitably have unintended negative effects on markets.

Removing the dependency on the dollar would be a good start, but it is not obvious how much that can be done since America's recent loan-based spending spree has been propped up by China's heavy investment in the dollar. Putting a higher proportion of money into the euro could have the knock-on effect of damaging the Americans' buying power, which would slow down their spending on Chinese imports.

Buying into commodities such as oil and gas could bring the reserve levels down. The problem there is that in order for China to make a dent in its reserves, it would have to buy quantities on such a vast scale that it would in turn bump up prices for everyone else. With many commodity prices already at unprecedented highs, it would be an extremely unpopular move to make them even higher.

Maintaining the status quo

Diversifying from dollars to commodities and euros could only be done to a limited extent. Perhaps a stalling tactic could be used, one that has some benefits, and at least slows down the growth in reserves. One way this could be done is by spending the money on benefits for Chinese citizens, whose access to free education and healthcare has been cut back dramatically over the last few decades. Those especially in need are the scores of millions of migrant workers who have foregone the state safety net by leaving their hometowns and the ever growing number of ageing people who are seeing smaller and smaller pensions.

Chinese people are world-class savers, and it is their reluctance to spend that has hampered the creation of a domestic market in China, thereby tilting its economy heavily towards exporting. One of the advantages of providing extra benefits to Chinese citizens is that they will feel less inclined to save, leaving the unsaved money to stimulate domestic spending.

The downside is that, in spending the reserves by providing benefits at home, the foreign currency has to be converted into local currency, which makes the RMB more valuable. This is an unattractive outcome for the Chinese government, which wants to keep the RMB low to make the country's exports more attractive. The easiest way to counter the consequent rise is to put more money into foreign reserves.

It might therefore be possible for a balancing act to be achieved: with the existing reserves, money can spent on benefits for Chinese citizens, and the incoming money, currently at about $18 billion a month, can be put into foreign reserves to stave off the increase in the RMB's value.

If carried out successfully, it is possible that some of the reserves could be spent, whilst at the same time kept at a constant amount by the money that is still coming into China. The safety net will still be there if the economy takes a dip, and some of the reserves will be spent on helping the poorer Chinese and the RMB will be kept at a constant value.

This may or may not be the course of action that the leaders in Beijing will take - chances are that no one will know what they will do until they do it - but one thing is for certain: having a trillion dollars opens up a wide range of possibilities.