By Keith Bradsher
As markets around the world have churned, China has long taken comfort in having what in the financial world amounts to a life preserver: its vast holdings of other countries' money.
A year-and-a-half ago, China held as much as $4 trillion in foreign exchange reserves. The reserves represented a symbolic trophy for China's leaders, who have described them as the "blood and sweat" of the workers and upheld them as a sign of national strength.
Now, as China's economic growth slows, that sign of national strength is slowly ebbing.
China's foreign exchange reserves are shrinking steadily as money flows out of China and Beijing moves to shore up its c urrency. The country's reserves have shrunk by nearly a fifth since summer 2014 — and more than a third of the shrinkage has been in the last three months. By the end of January, reserves stood at $3.23 trillion, a level that has prompted speculation about how much lower Beijing will let them go. With a smaller pot of reserves, Chinese leaders have less room to maneuver, should the economy undergo a sudden shock. The reserves situation also weakens China's control over the value of its currency, the renminbi. The drop in reserves could also hurt China's efforts to raise its global profile, as it doesn't have as much money to pump into high-profile projects in developing countries.
"If you use up $700 billion of reserves, how much more is going to follow? That is the basic problem," said Guntram Wolff, director of Bruegel, a non-profit economic research institute in Brussels.
Chinese officials are fighting back. In a rare interview published last weekend by Caixin, a Chinese magazine, Zhou Xiaochuan, the governor of China's central bank, said, "China has the largest volume of foreign exchange reserves in the world, and we will not let speculative forces dominate market sentiment."
China's reserve hoard is a byproduct of how it manages its currency. During China's biggest boom years, i ts currency could have risen in value as huge sums in dollars, euros and yen flowed into the country. Instead, Beijing tightly controlled the value of the renminbi, buying up much of the inflows and putting them into its reserves instead. That brought angry accusations from the United States and Europe that it was manipulating its currency to help keep Chinese exports inexpensive and competitive in foreign countries.
Now that the renminbi faces pressure to fall, China is spending its reserves in an effort to prop up the currency. But many American lawmakers and presidential candidates still accuse China of keeping its currency artificially weak. The reserves are still considerable, more than double Japan's, which has the world's second largest amount. The central bank chief, Zhou, and others have questioned whether the reserves were too big and the money could be better invested if left in the private sector. Zhou led a move over the last two years to make it easier for Chines e companies and families to invest their own money overseas, only to find in recent months that the outflows have been disconcertingly fast at times.
The erosion of reserves is also politically awkward, given public perception, and Beijing has taken steps aimed directly at shoring them up.
One move would keep more of its reserves free of long-term commitments. China's central bank now demands that at least some foreign money managers who want to invest part of the reserves pledge to achieve an annual return of as much as 26% or else their management fees will be reduced. Chinese markets rose this week, as some investors bet that China could slow the erosion. Expectations have faded that the Federal Reserve will keep raising interest rates this year, making China look more attractive. And China is running huge trade surpluses, bringing in a steady inflow of foreign money.
Economists inside and outside China are increasingly trying to guess how far reserves must fall before China might consider a sharp devaluation of the currency. An IMF model suggests that an economy of China's size needs $1.5 trillion with strict capital controls and $2.7 trillion without them