Some Issues Regarding China’s Foreign Reserves

Abstract

This chapter answers some interesting questions on China’s foreign reserve holdings: Are they excessive? Why so much? How to invest them? We first use the popular reserve adequacy measures to examine if China’s foreign reserve holdings are excessive. All the exercises suggest that China is holding too much reserves. We then analyze the motive of reserve holdings from a new aspect: foreign reserve holdings could be self-augmented. We also investigate the problem of how to set up a better portfolio for foreign reserve investment. The simulation in our model suggests that if foreign reserves are used to hedge against potential macroeconomic risks, it may raise the social utility by 56%.