Does US partisan conflict affect China’s foreign exchange reserves?

Abstract

Despite the claims that China has been implementing mercantilism policies to support its exports, recent studies argue that the dominant factor affecting China’s foreign exchange reserves is the precautionary motives. Apart from the economic uncertainty, political instability may be another risk source to consider by those motives. This study intends to empirically investigate how a particular factor originated in the US such as partisan conflict or economic uncertainty explains the foreign exchange reserves hoarding in China. Using SVAR models we find strong evidence suggesting that partisan conflict is positively associated with China’s reserve level, and has a primarily dominant role in predicting the surge in China’s foreign exchange reserves. In contrast, the impact of the US economic uncertainty is found negative and less persistent. The Forecast-error-variance decomposition (FEVD) analysis confirms partisan conflict’s dominant role in explaining the variations in China’s reserve accumulation, in comparison with other variables such as US exports to China and US economic policy uncertainty. The results are robust and consistent under different scenarios and robustness checks. The findings have important policy implications and contribute to the existing literature on the global impacts of US political instability.