China has not diversified its reserves …

And it intervened like mad last year, spending $195 billion to buy new reserves in the market over the course of 2004.

Valuation gains only accounted for $12 billion of the $207 billion overall increase in China’s reserves. That suggests most of China’s reserves were in dollars at least at the beginning of the year, and that it was not buying too many euros when the euro was around 1.2 during the first part of 2004. Nouriel and I may need to revisit our estimate of the PBOC’s dollar holdings.

China intervenes almost exclusively in dollars, at least in the first instance -- Nomura has done some good work on this. What we don’t know is what happens after China initially buys dollars; i.e. whether China converts any of the dollars it buys for renminbi into euros, pounds or yen. Increasingly, though, it looks like China keeps most of its reserves in dollars. It just does not use those dollars to buy Treasuries through channels that show up as a "Chinese" or a "central" purchase of US Treasuries in the US TIC data.

Only half of this reserve increase was sterilized, making the fall in China’s inflation rate a bit of a puzzle. $98 billion in unsterilized reserves should lead to an increase in the money supply equal to about 6% of China’s GDP.

One last point: China’s small global trade/ current account surplus is often cited by those who argue that the renminbi is not overvalued. Well, the data is in (see yesterday’s Wall Street Journal), and it turns out that China is running a signficant current account surplus. China’s estimated surplus was $70 billion in 2004, a bit over 4% of China’s estimated GDP. That is a large surplus for a country with a very resource intensive economy, given the upward move in commodity prices (China experienced a negative terms of trade shock in 2004). It is a large surplus for a country that is attracting large, sustained FDI inflows. It is also a large surplus for a country in the midst of an absolutely incredible investment boom. [Slightly edited, BWS]

China’s current account surplus is smaller than China’s bilateral trade surplus with the US, but that doesn’t mean it is small.

That is why China is likely to continue attracting large capital inflows even if it lets its currency move up just a bit:

"A 5 per cent revaluation may be seen as being the thin end of the wedge," said Aziz McMahon, currencies strategist at ABN Amro. "Speculators may think this is a one-way bet and flows could double again."

The data showing China’s January and February reserve increase should be interesting ... We will see if China has been able to scale back its reserve accumulation like the rest of Asia. It probably is not intervening at the same pace as in q4, but the size of its January trade surplus suggests significant continued intervention.