China and the Trade War: How Liquidity Reserves Can Affect the Game

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A country’s total reserves can have a dramatic impact on its economic policies. In this post, we’ll look at the countries with the top reserves, especially China, and how that should impact China’s trade wars with the U.S.

  • Liquid reserves allow countries significant leverage in economic policies and trade wars.
  • China currently holds over $3 trillion in reserves, far higher than Japan’s second-place $1.24 trillion in reserves.
  • China also holds a significant amount of U.S. debt, forcing them to walk a tight rope with the U.S.; they don’t want to rock the boat too much, but they have tremendous leverage to use if necessary.
  • If China were to sell off its reserves, it would have cascading effects on the economy, including driving up U.S. interest rates.

You don’t fight a trade war without ammunition on both sides. In compiling the data of the largest reserves–or total reserves measured in U.S. dollars–you’ll find a keen perspective as to why the markets seem to react to every headline related to the U.S.-China trade wars.

Why do liquid reserves matter? As it relates to trade wars, a country’s reserve stockpile has a large say in how much economic weight it can throw around. If China stockpiles a large amount of U.S. dollars, it can influence the value of its own currency, the yuan, which is pegged in U.S. dollars. Given that China holds over $3 trillion in reserves–far higher than Japan’s second-place $1.24 trillion–any movement from China can mean massive economic consequences for the globe.

Top 5 Countries with the Biggest Liquidity Reserves

1. China: $3.09 Trillion
2. Japan: $1.24 Trillion
3. Switzerland: $744 Billion
4. Saudi Arabia: $496 Billion
5. Taiwan: $462 Billion

How (and Why) Countries Use Liquidity Reserves

The reason any investor would want to hold liquidity is obvious: it makes an investor more flexible. It keeps one’s options open. But on a geopolitical level, liquidity has far-ranging uses. Countries can employ these reserves strategically to help manage the supply (and value) of their home currencies. This, in turn, can influence the price of exports. If a country like Japan manages its reserves well, it can compete with dominant exporters like China by making its products relatively cheap to consumers like the U.S. These reserves give countries economic power and financial weight for throwing around.

We constructed this graphic according to IMF Data, which provides a comprehensive list of variables that go into factoring each country’s liquid reserves.

How the Reserves Impact the U.S.-China Trade War

Because the exchange rates between currencies have such an impact on a country’s exports, one can expect these numbers to have a drastic effect on trade wars. In particular: the U.S.-China trade war.

Consider that China holds a significant amount of U.S. debt. This gives China leverage if they’re unable to otherwise respond to tariff threats from the U.S. China’s ability to buy up U.S. government debt also means that it has the ability to unload that debt in massive amounts at a moment’s notice. Drastically increasing the market supply with U.S. treasuries would, in turn, push down U.S. bond prices. With lower bond prices come higher yields, discouraging the free flow of credit in the U.S.

If China were ever to sell off these reserves, notes Bloomberg: after a cascade of effects, such a move could also drive down the value of the U.S. dollar. Low currency costs would mean that U.S. products are cheaper and more competitive on the global marketplace.

China faces a delicate balancing act with its substantial reserves. Though it could drive up U.S. interest rates, driving down the value of the dollar would also have adverse trade consequences. Watching how China manages its substantial reserves will be integral to understanding the progress of the trade war.

Data: Table 1.1

 

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