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Roula Khalaf, Editor of the FT, selects her favourite stories in this weekly newsletter.

The writer is a senior fellow at the Council on Foreign Relations and a former US Treasury official

China continues to buy US dollars at pace, and it is no doubt amassing additional holdings of foreign securities too. In December, its state banks and central bank bought more than $100bn of foreign exchange in the market. January purchases were only slightly smaller. 

If you are only looking at the balance sheet of the People’s Bank of China, this might not have been evident. The formal foreign exchange reserves of China’s central bank have not been rising rapidly, but do not be fooled. The dollars that China Inc bought in the market in the past few months are being warehoused by the country’s big state-owned financial institutions, which added the unprecedented $100bn to foreign assets in December and another $70bn in January.

These are huge, market-moving numbers. They showed beyond any reasonable doubt that China’s massive trade surplus once again flows through the balance sheet of its core state financial institutions.

Exporters now want to sell their dollars for renminbi to capture the renminbi’s expected appreciation (off a very weak level) rather than warehouse their export proceeds in Hong Kong, Singapore and other offshore centres. To offset that demand for renminbi, China’s state banks had to buy a ton of foreign exchange. The $100bn a month in purchases in December set a new record for intervention.

Yet rather than discussing where China Inc will warehouse all the foreign exchange that is now in the hands of the state, much of the financial world is talking about signs that China is diversifying away from the dollar and US Treasuries. That makes no sense.

To be sure, the number of Treasuries that Chinese investors hold in US custodians has fallen sharply over time. That reflects the relatively low share of dollars in China’s reserves (presumably under 55 per cent, the last disclosed number) as well the use of non-US custodians. And China has — since at least 2010 — gone to great lengths to try to limit its US holdings, and even greater lengths to limit its visible US holdings. That shift has meant that the correlation between China’s current account surplus, its reserve growth and its holdings of US bonds has broken down.

But that does not mean that China’s state — broadly defined — stopped accumulating dollars. Rather, dollar asset accumulation has shifted from China’s State Administration of Foreign Exchange agency ($3.4tn in foreign exchange reserves, an estimated 50-55 per cent in dollars) to the state banks (about $3tn in assets, with maybe 70 per cent in dollars, according to my estimates from China’s own data for the commercial banks). 

Diversifying the use of China’s reserves initially meant handing over China’s reserves to the policy banks that support development or trade initiatives such as the Belt and Road projects around the world. Dollars that could have been reserves were used to fund “entrusted loans” and inject equity ($95bn in 2015). China does not report the size of the foreign currency balance sheet of China Development Bank and the Export-Import Bank of China, but independent estimates suggest total assets of about $1tn. 

More recently, the locus of foreign asset accumulation shifted to the state-owned commercial banks, which now have $1.65tn in disclosed foreign assets. That includes some renminbi-denominated loans, but the bulk of these foreign assets are in dollars and euros. The PBoC reports that the state commercial banks hold $450bn in foreign currency denominated securities and credit extended to other financial institutions. The state banks can take credit risk, but they must be straining at the scale of recent inflows.

Put simply, China has a $1tn current account surplus (only reported to be $735bn, but there is growing consensus that the reported number is understated). As such, it has to be accumulating a lot of foreign assets. 

Such a country cannot easily diversify away from dollar assets if it still wants to manage its currency against the dollar by selling the renminbi to buy it. That is all the more the case if it wants to cling to a weak currency to support exports at a time when domestic sources of growth are weak.

If Chinese state investors are not directly buying Treasuries, they are lending money to other global investors who are. That is the only way the global flow of funds can add up. Ignore the amateur geopolitical strategists talking eloquently about the end of dollar dominance and follow the money.