Strategic Asset Allocation for China's Foreign Reserves:A Copula Approach

In this paper, we study strategic asset allocation for China＇s foreign reserves using a risk- based approach. Four aspects of the risk management are investigated： an investment universe, dependence structure, allocation strategies under risk minimization and trade-off between risks and returns. A regime-switching copula model is developed to investigate the dynamic dependence between assets. One regime emphasizes a short-term safe asset and the other regime emphasizes a long-term safe asset. The optimal allocation is derived following two strategies： risk minimization and trade-off between risks and returns in utility maximization with disappointment avoidance, lf the central bank focuses solely on risk minimization, the asymmetries in the asset return dependence encourage the flight to safety. However, if higher risks are allowed in exchange for higher returns, even the exchange is very conservative, and the asymmetries would discourage the flight to safety. Therefore, we suggest that China should mitigate its flight to safety after 2008 and increase holdings of short-term bank deposits, long-term treasury bonds and euro bonds.

How China's Holdings of Foreign Reserves Affect the Value of the US Dollar in Europe and Asia

By January 2009, China held almost US$2tn in foreign reserves. The present paper estimates the marginal effect of China changing its holdings offoreign reserves on the value of the US dollar in Europe and dsia. Because using traditional techniques to find this estimate would be inappropriate due to severe problems resulting from omitted variables, the present paper uses a new approach, bidirectional-reiterative trucated projected least squares, that has been proven to minimize problems associated with omitted variables. It is found that if China would sell 1 percent of its foreign reserves, then the value of the US dollar would fall by 0.44 percent. With such a large effect, China has an incentive to either not sell arty of its US dollar reserves or sell all of its US dollar reserves.

The Exorbitant Privilege of US Treasuries and China's Choices in the New Era

After the decoupling of the US dollar from gold in 1971,US Treasuries replaced gold as the value benchmark of the international monetary system and acquired an exorbitant privilege.Subsequently,the total amount of US debt exhibited an exponential expansion trend,unbound by any substantial constraints.The so-called debt ceiling is a partisan game rather than a rigid fiscal constraint on the United States.As long as there are no fundamental changes in the global monetary system,the international credit of US Treasuries will stay stable,and their trend of infinite expansion will be sustained.Massive quantitative easing policies have failed to significantly shake this stability,and the notion of global investors offloading US Treasuries is more an illusion than a fact.The exorbitant privilege of US Treasuries grants its federal government the“freedom to borrow,”shielding the American financial sector from due penalties during global financial crises and securing excessive returns in global capital cycles.In the old days when running“twin surpluses”on capital and current accounts,China kept the value of Renminbi low to support its export manufacturing sector along the southeast coast.As a result,China accumulated huge foreign exchange reserves,mainly US Treasuries.Nowadays,this practice is no longer necessary,yielding low returns and posing significant security risks.

The Changes in World Oil Prices, Monetary Factors, and Foreign Index Toward Composite Index Movement： Indonesian Case for the Period of 2005-2011

Capital market is one of the drivers of the economy through the formation of capital investor excess as well as an indicator of a country＇s economy. Movement of stock price index is often influenced by many factors, derived from the company＇s performance, monetary factor, and changes in world oil prices. This study highlights the problem in world oil prices due to political turmoil in the Middle East. The samples are taken from the Jakarta Composite Stock Price Index （JCI）, oil prices, Indonesian inflation rate, Certificate of Bank Indonesia＇s （CBI） rate, and the reserve assets, during the period from January 2005 to December 2011 （84 months）. Using the data published by the Bank of Indonesia, reports of the Central Bureau of Statistics （Biro Pusat Statistik, BPS）, and other relevant sources, the data analyzed through the Eviews 7.1. The main objective of this study is to examine the effect of oil prices, foreign stock price index, and monetary variables （inflation rate, CBI rate, country＇s foreign reserves, and others） toward the JCI analyzed through the error correction model （ECM）. Hypothesis testing with the F-test for the 95% confidence level indicates that the oil price, exchange rate （Indonesian Rupiah （IDR）/United States Dollar （USD））, CBI rate, foreign exchange reserves, the Dow Jones Index, and the Taiwan stock index, both simultaneously as well as partially have a significant influence on the JCI.

China's Rapid Accumulation of Foreign Exchange Reserves and Its Policy Implications

In late February 2006, China surpassed Japan to become the world＇s largest holder of foreign exchange reserves. Beijing is now faced with the growing challenge of how to handle these vast reserves effectively. Although China＇s soaring foreign exchange reserves indicate that its overall strength has grown, they have created internal and external pressures on the balance of the economy, and introduced risks to the financial system. It is estimated in the present study that foreign exchange reserves of approximately US$ 400bn in 2005 would have been appropriate under circumstances of a managed floating exchange rate regime and capital control. China ＇s actual reserves have far exceeded its normal demand. The objective of China is to maintain an optimal level that maximizes net benefits as a whole, Four main policv options are available for China to achieve its target： spending and investing foreign exchange reserves, gradual liberalization of the capital account, diversification of foreign exchange reserves and a switch in holders of foreign exchange reserves. Spending and investing in foreign exchange reserves can be undertaken in combination with liberalization in the capital account, given careful consideration of the risks involved. Liberalization should be extensive but gradual so that companies and individuals can adjust to changes in financial markets and manage portfolios while avoiding unnecessary risks.

Why China Should Invest Its Foreign Exchange Reserves in the Major US Banks

The subprime mortgage crisis and the resultant inflationary monetary policy in the USA have left the Chinese economy subject to four risks in particular. First, China＇s exports to the USA might continue to decline. Second in the medium term, the higher US inflation rate will lead to a weak dollar, which will negatively affect China＇s exports. Third in the long term, when the US Federal Reserve decreases money supply to control inflation, the US economy might enter another recession, hurting China ＂s exports further. Fourth, China＇s foreign exchange reserve assets might suffer heavy losses when the US inflation rate rises. Conventional foreign exchange investment strategies are insufficient for dealing with these four risks. Investment by China in the major US banks is suggested in the present paper. This strategy would mitigate if not eliminate all four risks. China could gain considerable financial returns on investments with only moderate risk.

Rethinking Fast Growth in China's Foreign Exchange Reserves

The sustained surpluses in the current and capital accounts of balance of payments are the main reason for the continuing rapid expanse of China＇s foreign exchange reserves in recent years. However, flaws in the formation of the renminbi exchange rate regime are the institutional root cause of the sustained high growth in foreign exchange reserves. Various theoretical misconceptions about the scale of foreign exchange reserves have swayed policies and contributed to its sustained fast growth. Sustained high growth of China＇s foreign exchange reserves, and its extraordinary large scale, carry tremendous risks. Because the security of foreign exchange reserves affects a country＇s financial safety, China urgently needs to adjust its foreign exchange reserve policies.

An Analysis of the Determinants of the Changes in China's Foreign Exchange Reserves' Nominal and Real Rates of Return

We use decomposition and regression to examine the reasons for the changes in nominal and real rates of return of China＇s foreign exchange reserves between 2002 and 2009. The results show that the US financial market risk premium is the most important determinant of changes in the nominal rate of return, while the US dollar exchange rate and the bulk commodity price are the two key determinants of changes in the real rate of return. From empirically based research, one may conclude that the loose monetary policy of the US Federal Reserve increases China＇s foreign exchange reserves＇ nominal rate of return but decreases the real rate of return and that the European debt crisis has an uncertain impact on China＇s foreign exchange reserves＇ nominal rate of return but may well raise the real rate of return.

Modelling State Foreign Exchange Reserves under the Managed Floating Exchange Rate System in China

The purpose of this paper is to investigate China′s state foreign exchange reserves growth using monthly data in the period January 1994 to December 1998. An economic model is constructed, with a view from its formation mechanism. Time series techniques are used to examine the long run relationship between foreign exchange reserves and the variables included in the model. Our empirical investigation revealed existence of a systematic long run relationship among foreign exchange reserves, exports, imports, and foreign direct investment. In the short run, the Asian financial crises have not significant effect on China′s foreign exchange reserves. Moreover, the recursive tests results indicated that the error correction model was structurally stable over the sample period, implying that the reserve holdings play a significant role in the balance payments adjustment process and separating China economy from the Asian financial crises.

The Analysis of High Exchange Reserve and High National Saving in China

High resident saving and high foreign exchange reserve are the inevitable products in China during the period from planned economy to market economy, and there is high correlation between them. On the one hand, this kind of economic phenomenon can＇t persist in a long time; on the other hand, to implement relevant fiscal and monetary policy, foreign trade policy, and foreign exchange management policy to change them in view of their negative effects to present economy is one of the present economic tasks.

Analysis of China’s Foreign Trade Growth and Discussion of Related Policies

China’sforeign trade experienced threeconsecutive years of super-speed growth in 2002- 2004, even though the country was stricken by the SARS epidemic in 2003 and power shortages in 2004. What hasgone beyond expectations is that the exports trade still grew with momentum after the central governmentlowered theexportrebate ratesbyan average of3 percentagepoints, starting from January2004. Such growth momentum isapparently associated with external demand and the performance ofthedomestic macroeconomy, and even more associated with a seriesof support policies. Thispaper tries to raise issuesissues associated with these policies on the basis of an analysis of foreign trade performance in 2002-2004, in order to enhance understanding of the advantages and disadvantages of these policies, and to recommend a new line ofthoughtfor improving policy arrangements for the growth of import and export trade and for the harmonious development of the macroeconomy.

Internationalization of the RMB:An Evaluation Framework

As the Chinese economy continues to develop,China is becoming a more active player in the world economy,and the RMB is being more widely used in international markets.In this paper we use indicators representing the RMB’s functions of pricing,settlement and reserve to create an RMB Internationalization Index(RII)to evaluate the degree of the internationalization of the currency.We calculate the RII levels in 2010 and 2011,and find that the RII increased dramatically during these two years.However,when compared to the currencies of developed countries,the RMB is far from achieving complete internationalization.We propose a"three-step development"strategy for the RMB to be internationalized.

China's Sovereign Wealth Fund:Weakness and Challenges

The establishment of sovereign wealth funds in large developing countries has generated hot debate among participants in the international financial market. When accumulated foreign exchange reserves surpass a sufficient and an appropriate level, the costs, risks and impacts of holding reserves on the macroeconomy of a country need to be considered. The Chinese Government established China Investment Corporation （ CIC） in 2007 to diversify its investment of foreign reserves and to raise investment income. However, because of certain conflicts of interest and institution-design caveats, CIC possesses some internal weakness, including a vague orientation, mixed investment strategies and an inefficient bureaucratic style. Although the subprime crisis has softened certain regulations and lessened rejection by the USA of ClC potential investments, the increased volatility and uncertainty of the market means that CIC is facing some new challenges in terms of its investment decisions. Moreover, CIC is competing with other Chinese investment institutions for injections of funds from the Chinese Government.

Would China's Sovereign Wealth Fund Be a Menace to the USA?

The sovereign wealth club acquired a new member with the official launch of the China Investment Corporation （CIC） on 29 September 2007. The arrival of CIC has further heated up debate regarding sovereign wealth funds （SWFs） and their potential implications for global financial markets. This is because, in carrying out its investments, CIC can tap into China＇s huge official foreign exchange reserves, which by April 2008 had surged to US$1.76tn. CIC＇s initial working capital of US$2OObn makes it the fifth largest SWFs in the world today. This article seeks to analyze CIC＇s investment strategies, as well as their potential economic and political implications for global as well as US financial markets.

The Threat of Financial Sanctions:What Safeguards Can Central Banks Build?

The sanctions imposed by the G10 countries on financial institutions in Russia,including on its central bank,mil come under scrutiny by emerging market central banks.This will help them build appropriate safeguards against disruptions to cross-border transactions and revise their investment mandates to reduce the risk of reserve asset freezes.Building new1 financial market infrastructure and cross-border payment systems,or strengthening existing ones,will become the priority of emerging global powers.The goal will be to build systems that support democratic governance mechanisms,have oversight arrangements involving the central banks of trusted countries,and promote fair and safe access to clearing and settlement under well-defined policy guidelines.The use of alternatives to the US dollar as the invoicing currency in international trade will gather momentum.Markets for energy and other commodities will be the change drivers.China has an important role to play.

Transforming Central Bank Liabilities into Government Debt： The Case of China

Where policy has substantially increased central bank assets, the corresponding liabilities present an opportunity to increase the breadth, depth and liquidity of the government bond market. In China＇s case, transformed illiquid central bank liabilities couM double or triple the stock of government bonds. Central bank liabilities can be transformed into government bonds either through the government ＂s purchase of foreign exchange reserves held by the central bank or by the government overfunding its borrowing requirement and depositing the proceeds in the central bank. The overfunding approach is preferred if, for financial stability reasons, it is judged prudent to leave the central bank with sufficient resources to serve itself as lender of last resort in foreign currency to the banking system. In the case of China, public debt consolidation could also contribute to further liberalizing the Chinese banking system, wider international use of the renminbi and more balanced holdings of key currency government bonds.

Assessing China’s recent capital outflows:Policy challenges and implications

China has experienced a dramatic swing from net capital inflows to large net outflows in recent years.The recent capital exodus to some extent reflects policy difficulties and obstacles that China’s authorities face in managing economic reforms.In particular,China faces tough challenges in balancing the benefit/risk trade-off from capital account opening and attempting to introduce more flexibility to the currency.Moreover,the lack of policy clarity highlights policy inconsistencies and ambiguities among Chinese leaders in macroeconomic management,as more often than not,government policies seem to alternate between emphasizing reform and growth.This may cast doubt on the Chinese leadership’s commitment to reform,undermine confidence in the economy and cause further capital outflows that will have significant repercussions both for China as well as for the world.

Political and Economic Analysis on SWFs of Saudi Arabia

Sovereign Wealth Funds established by Middle Eastern countries occupy an important position in world capital markets in terms of size or activity.However,regarding the establishment and operation of the funds,Saudi Arabia pursues a conservative investment strategy as a regional power,which is quite different from other Gulf countries.It is found that the economic conditions in Saudi Arabia,such as money supply,foreign exchange reserves,external debt and domestic economic development,which are generally considered to be the determining factors for the establishment of SWFs,were not favorable compared with those in the other GCC states in the last decades.However,even when those conditions have been improved since the beginning of this century,the performance of SWFs in Saudi Arabia still lags behind compared with other Gulf countries.As the economic indicators of the country will be studied,so will a political analysis be conducted in three specific perspectives:the significance of US dollar reserve for Saudi-US diplomatic relations,the deterioration of political environment of FDI in western countries after 9/11 and a mix of public and private ownership systems brought by the royal family.In the end,one can conclude that Saudi Arabia is a conservative investor on SWFs.