China’s burgeoning mountain of foreign currency reserves has finally breached the $1 trillion mark, the country said yesterday, raising questions over how long it can sustain its present monetary and exchange rate regime.

Official figures for the scale of Beijing’s foreign exchange holdings have yet to be released, but state television reported that they had reached $1 trillion (£527 billion). The news had been expected, with China’s currency holdings officially standing at $987.9 billion in September and these rising by about $18.8 billion each month this year.

Even before exceeding $1 trillion, China was the largest national holder of foreign exchange, holding an estimated fifth of global reserves, with about 70 per cent of these denominated in US dollars.

The huge stockpile is being swollen as the booming Chinese economy expands at annual rates of 10 per cent or more, sucking in vast quantities of foreign currency from buoyant export trade, massive inflows of foreign direct investment and speculative inflows of foreign capital staked on expectations of a future revaluation of the Chinese yuan currency.

Because Beijing has insisted for now on holding down the yuan’s value to maintain its super-competitive status in world markets, its central bank has been forced to buy up this inflowing tide of foreign exchange to prevent it driving up the value of its own currency, leading in turn to the mounting reserves stockpiled by the People’s Bank.

However, economists and the Chinese authorities are increasingly worried about the knock-on repercussions of the accumulation of foreign currency. A key problem is that as the People’s Bank buys up the foreign currency, it must do so in return for yuan, which are then pumped into the Chinese economy as a side-effect. Although the central bank tries to neutralise the effects of this through so-called sterilisation, it is unable to mop up all the extra funds. The result is that this creates both the risk of inflationary pressures and the reality of excess investment as commercial banks lend excess yuan to borrowers eager to cash in on the Chinese boom.

“It’s kind of like shooting cocaine into the veins of the economy — it’s a stimulant,” Stephen Green, of Standard Chartered, in Shanghai, said. At the same time, China also faces the problematic task of managing the accumulated foreign currency mountain.

While a key concern is that it could endure huge losses on its dollar holdings if the US currency depreciates, the very scale of its stock of dollars makes it hard to diversify into other denominations. Any large-scale attempt by Beijing to do so would risk triggering a dollar slump, presenting it with enormous, self-inflicted losses.

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