CONFIDENTIAL #2
6
12.
Given the pent-up demand in China for imported consumer goods, there was considerable scope for using the
excess reserves to finance such imports. However, given China's stage of development and development plans, this
would almost certainly be an inefficient use of hard-won
savings in that it would not yield any significant future
return although it might have political benefits.
13.
Purchasing physical assets to enhance China's future output was the most obvious way to use up excess foreign exchange reserves. However, there is a limit to an economy's ability to absorb new investment within a
given timespan and attempts to exceed that limit are likely to be wasteful. Despite China's large backlog, the
concept of a limit to the rate at which absorption of new investment and of new technology would be appropriate still applies. Thus, although it would probably be sensible for China to apply the bulk of the excess
reserves to the purchase of physical assets for use in China, it was not necessarily inappropriate for some of
them to be used to purchase assets overseas.
14.
In some ways the problem is akin to that faced
by the UK in deciding the best way to use the windfall
gain in its reserves from North Sea oil. It is not a
choice between using them for China's benefit or using
them for the benefit of foreigners but between using them
for China's benefit now or preserving them as best as
possible for use for China's benefit in the future.
15.
As regards the value of the reserves being eroded by inflation, this is again a question of the efficiency with which they are used. Given the positive real returns available on foreign currency assets, e.g. US
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