Originally posted July 3, 2016.
I want to focus on the composition of China's foreign reserves, explain why the liquid portion of the reserves may be much smaller than widely believed, and how that situation is bearish for RMB and bullish for gold.
According to Wikipedia:
"The foreign-exchange reserves of China are the People's Republic of China holdings of cash, bank deposits, bonds, and other financial assets denominated in currencies other than China's national currency (renminbi). At the end of January 2016, the foreign-exchange reserves of China stood at US$3.23 trillion. The management of foreign-exchange reserves is governed by the State Administration of Foreign Exchange and the People's Bank of China. The composition of foreign-exchange reserves is a state secret in China."
We managed to retrieve the following financial data from the China State Administration of Foreign Exchange (SAFE) website (www.safe.gov.cn):
|官方储备资产（ 2016.01 2016.05 ） |
Official reserve assets
Foreign currency reserves
IMF reserve position
Other reserve assets
Template on International Reserves and Foreign Currency Liquidity
As at Apr 30 2016
I. Official reserve assets and other foreign currency assets (Approximate market value)
|A. 官方储备资产 |
Official reserve assets
|（1） 外汇储备（可兑换外币） |
Foreign currency reserves (in convertible foreign currencies)
of which: issuer headquartered in reporting country but located abroad
Total currency and deposits with:
other national central banks, BIS and IMF
banks headquartered in the reporting country
of which: located abroad
banks headquartered outside the reporting country
of which: located in the reporting country
|（2） 基金组织储备头寸 |
IMF reserve position
|（3） 特别提款权 |
|（4） 黄金（包括黄金存款和适用情况下的黄金掉期） |
Gold (including gold deposits and, if appropriate, gold swapped)
volume in millions of fine troy ounces
|（5） 其他储备资产 （请列明） |
Other reserve assets (specify)
loans to nonbank nonresidents
|B. 其他外币资产 （请列明） |
Other foreign currency assets (specify)
securities not included in official reserve assets
deposits not included in official reserve assets
loans not included in official reserve assets
financial derivatives not included in official reserve assets
gold not included in official reserve assets
As expected, this disclosure didn't say a whole lot, as 97% of the reserves assets fall into category A(1) -- "Foreign currency reserves (in convertible foreign currencies)". Furthermore, 99% of category A(1) falls into the A(1)(a) "Securities" category.
So what's in the "Securities" category?
The following article published September 2, 2015 in Nikkei Asian Review entitled "Does China really have $3.6tn in foreign reserves?" reported:
"Funds available for foreign currency purchases declined because the authorities had to sell Treasurys to meet demand for dollars and other foreign currencies associated with capital flight. 'The PBOC has sold at least $106 billion of reserve assets in the last two weeks, including Treasurys, according to an estimate from Societe Generale,' U.S. wire service Bloomberg reported Aug. 27.
According to data from the U.S. Treasury Department, China's Treasury holdings -- $1.82 trillion -- were only about 45% of its total foreign reserves...
China invests some of that money in Euro bonds, Japanese government bonds and Japanese, U.S. and European stocks, but 'it is unknown how China manages at least $1 trillion of foreign reserves,' said a veteran market economist."
Through the US Treasury Department's website (https://www.treasury.gov/resource-center/data-chart-center/tic/Pages/ticsec2.aspx), I was able to plot the following:
China's US Treasury holdings (in US$ Billions)
It's clear China's US Treasury holdings have held steady between US$1.2 and $1.4 trillion during 2010 to 2016, and likely comprise the single most significant portion of the category A(1)(a) "Securities".
And what about the other US$2 trillion under "Securities"?
Based on publicly available information, the answer led us to China Investment Corporation (CIC), which is a sovereign wealth fund responsible for managing part of the People's Republic of China's foreign- exchange reserves. CIC was established in 2007 with approximately US$200 billion worth of assets under management. At the end of 2014, the CIC had over US$740 billion in assets under management. CIC's holdings increased from US$200 billion in 2007 to over US$740 billion by means of capital gains, income gains or additional cash/asset injections by the People's Bank of China/SAFE. If we assume CIC's assets stay at US$740 billion today (although they are likely to have increased, as they have every year since 2007), they will make up over 23% of China's total foreign reserves holdings in 2016.
Adding up the numbers, this leaves us with roughly US$1.2 trillion worth of unexplained assets remaining under "Securities".
To answer the question of what these "Securities" are, we have to first examine what's held in CIC, then we will come back to where we think the remainder of the "Securities" went, as I believe through my research, that those two issues are interlinked.
What makes up CIC's fund?
We retrieved the following financial information from CIC's latest annual report from its website (http://www.china-inv.cn/):
The composition of the above 2014 Global Investment Portfolio Distribution pie chart is, I assume, a breakdown of the "Financial assets" under the balance sheet (i.e. 2014: US$225,321 million).
How about "Long-term equity investments" under the balance sheet (i.e. 2014: US$489,147 million)? This investment grew from US$171 billion to $489 billion in 2014, consistently generated 15% to 20% annual investment income, and is what drove CIC's meteoric rise in asset base.
The 2014 Annual Report is vague about what CIC's "Long-term equity investments" are. I managed to find out under a footnote in the 2010 Annual Report:
CIC's Long-term equity investments are "*Principally comprised of investments by Central Huijin".
So, what is Central Huijin?
Central Huijin Investment Ltd. (Chinese: 中央汇金投资有限责任公司) is a Chinese investment company owned by the government of the People's Republic of China. It is a wholly-owned subsidiary of CIC, and an organization through which the Chinese government can act as a shareholder of the "big four" state-owned banks, thereby improving corporate governance and initiating reforms in the banking industry.
According to CIC's 2014 Annual Report, Central Huijin held the following equity stakes in China's major banks:
If we assume all of CIC's assets are included in China's foreign reserves, then 15% of the foreign reserves are stakes in Chinese banks. The peak in Chinese banking equities coincided with the peak in China's foreign reserves which hit US$4 trillion in 2014.
Only approximately US$225 billion worth of CIC's assets (under "Financial assets" in the balance sheet) are foreign assets in the form of equities and bonds. This number was echoed in an article published in The Wall Street Journal, March 27, 2015: "Ding Xuedong, chairman of China Investment Corp., which has about $220 billion in overseas assets, said in an interview with The Wall Street Journal on Friday that he sees diverging economic growth in coming years, with a resurgent U.S. leading the way."
Now circle back to the question: what's the remaining US$1.2 trillion worth of unexplained assets under China's foreign-exchange reserves category "Securities"?
Recall that CIC (which manages a portion of the China's foreign-exchange reserves) owns 47.63% of China Development Bank (CDB). CDB was the second-biggest bond issuer in China (after the Ministry of Finance) in 2009, accounting for about a quarter of the country's yuan bonds, and the biggest foreign-currency lender. At the end of 2010, CDB had US$687.8 billion in loans, more than twice as much as the World Bank.
The question then becomes: where did the US$687.8 billion in loans come from?
Reuters reported on April 20, 2015:
"The People's Bank of China will inject $32 billion into China Development Bank (CDB) and inject $30 billion into Export-Import Bank of China (EXIM), the magazine said in a report on its website, citing sources.
The capital injection will be conducted via converting entrusted loans into stakes, it said, adding that the central bank will become the second largest shareholder in the China Development Bank and the biggest shareholder of the Exim Bank.
The capital injections will provide long-term foreign currency for the banks to support Beijing's 'One belt, One road' initiative for boosting connectivity between Asia, Europe and Africa, it said....
China's cabinet said last week that it had approved the central bank's reform plans for CDB, Exim Bank and Agricultural Development Bank, in a bid to better finance projects during the current economic slowdown....
China had previously used part of its foreign currency reserves to recapitalise big state lenders to help them restructure and list their shares."
EXIM does not publish figures for overseas loans. However, U.S. officials estimate that it finances more than the total export financing of the Group of Seven industrialized nations combined.
It is entirely plausible that the remaining US$1.2 trillion worth of foreign-exchange reserves have already been lent to CDB and Exim and the newly created Asian Infrastructure Investment Bank (AIIB).
In summary, shocking as it may be, and contrary to popular belief, about two-thirds of China's foreign-exchange reserves are held in U.S. Dollars, approximately one-fifth in Euros, and almost all the rest in Japanese Yen and British pounds.
Here is what I think the breakdown is of China's foreign reserves:
- US$1.2 trillion in US Treasury holdings
- US$80 billion in gold
- US$740 billion in CIC (of which, approximately $500 billion is in stakes in Chinese banks, and $240 billion is in foreign equities and fixed income securities).
- US$1.2 trillion in equity stakes in, and loans to: CDB, Exim and AIIB.
This would also mean that less than half of China's foreign-exchange reserves are liquid i.e. in the form of Treasury notes, cash, and gold. China reportedly spent over US$50 billion in three days during August 2015 to support the RMB, and lost US$500 billion in reserves in 2015. The depleting of foreign-exchange reserves is particularly concerning given the country's current account surplus which exceeded $300 billion in 2015. This suggests a net capital flight in excess of $800 billion in 2015, and I fear the numbers may be even worse when we account for the over US$500 billion increase in gross external US dollar debt in 2015 over 2014.
Amid full-scale capital flight, the cash/US Treasury reserves could be depleted sometime in 2017. Such an event could spell market uncertainty ahead with a magnitude bigger than that caused by Brexit. Watch for the pace of gold's bullish trend and the RMB's bearish trend to accelerate.
Disclosure: I own physical silver and manage a company engaged in silver exploration.
 Y.Takita, "Does China really have $3.6tn in foreign reserves?" Nikkei Asian Review (2 September 2015).
 China Investment Corporation Profile. Sovereign Wealth Fund Institute. July 2, 2008. Retrieved August 27, 2013.
 J. Anderlini, "China investment arm emerges from shadows" Financial Times (5 January 2008).
 L. Wei, "China's CIC Gearing Up Investment in Overseas Assets" The Wall Street Journal (27 March 2015).
 M. Forsythe and H. Sanderson, "Financing China Costs Poised to Rise With CDB Losing Sovereign-Debt Status" Bloomberg Market Magazine (June 2011).
 K. Yao, "China to inject FX reserves into policy banks – Caixin" Reuters (20 April 2015).
 S. Reddy, "U.S. Export Financing Challenges China" The Wall Street Journal (12 January 2011).
 G. Wildau, "China's large forex reserves constitute both a blessing and a curse" Financial Times (30 September 2014).
 L. Wei, "China's Forex Reserves Fall by Record $93.9 Billion on Yuan Intervention" The Wall Street Journal (7, September 2015).
 C. Yap, "China's Forex Reserves Fall by Record $107.9 Billion on Yuan Fears" The Wall Street Journal (7 January 2016).