CHINESE RESERVES

A couple of months ago I suggested that China needs its reserves to, in effect, keep its banking system solvent. Here's an interesting hidden nugget from the San Fran Fed Bank:

The banking sector's biggest problem is asset quality--not surprising, given its historical relationship with state-owned enterprises. The official aggregate nonperforming loan ratio is now below 20%, but many analysts estimate that the true level exceeds 40%. To put the size of the problem in perspective, Standard & Poor's estimates that the full cost of writing off these loans could be $656 billion, or about 43% of forecasted 2004 GDP. Given the government's ownership, this has become a huge fiscal issue. Last January, the government recapitalized two of the healthier "Big 4" banks, China Construction Bank and Bank of China, injecting $22.5 billion into each institution and enabling them to write down bad loans; however, as I said, many have questioned the accuracy of reported asset quality improvement.

Just how much in reserves does China hold? $700 billion? But, Brad Setser advises: beware of currency mismatch (scroll through all the comments) between assets (foreign exchange reserves) and liabilities (remnibi bank deposits).Calling Cards