China Redux

China’s stock of foreign exchange reserves soared to $1.2 trillion in the first quarter of the year (China already was the largest holder of foreign reserves). Two things worth noting about this:

1. The rate of foreign reserves growth: the first quarter increase of $135.7 billion is equal to more than half of China’s total foreign growth reserve in all of 2006 ($247.3 billion).

2. The reason behind a substantial portion of the first quarter increase is still unexplained. About $60 billion of the $135.7 billion increase can be attributed to the first quarter trade surplus and to foreign direct investment. The source of the remaining $75 billion is unknown. Some obervers believe that Chinese financial institutions are bringing funds back home after storing them offshore, which is certainly plausible.

But that’s not the point.  Thomas Barnett explains why the case of the mysterious reserves is cause for concern:

Bigger point: the lack of transparency overall on Chinese monetary regulation and general reporting. China’s getting too big to be that opaque. Bad for us, bad for them, bad for business.

A good example of reality that’s China freedom deficit is less dangerous to us than its rules deficit. Too many rules on politics, not enough sensible ones on markets.

Lack of transparency is even more dangerous when the size of China’s foreign reserves is so great — and growing at a rapid rate. The silver lining is that China and the US share a mutual interest in a stable dollar. The problem is that without better information, there’s no telling how the markets will react. And as China’s reserves rise, the greater impact any glitch, misstep, or miscommunication might have.