China's Bad Investment?

By intervening in the market to keep its currency undervalued, China is lowering the purchasing power of its own consumers. Its trade surplus means that China is accumulating large amounts of foreign assets (what they're getting in return for all that stuff they're sending us), like US Treasury bonds. These assets will depreciate (in Yuan terms) when the Yuan is allowed to rise, so the Chinese government is setting itself up for a huge financial loss. Therefore, Brad Setser asks "Why is China's government trying so hard to hold down China's current living standard?"

The government of China, by contrast, seems determined to keep China poorer than it needs for to be. After all, the government of China, not the government of the US, actively intervenes in the market every day to hold China’s living standards down – or, if not China’s living standard, certainly the external purchasing power of all those paid in RMB.

....China’s policy of buying dollars (and to a smaller degree euros) also means that China is sinking a growing share of its national wealth into a set of assets that are almost certain to depreciate over time...

China – counting likely flows from Chinese banks as well as flows from the PBoC almost certainly bought about $200b of US debt in 2006. It paid – in RMB terms – a lot for those assets as well: China effectively has a policy of under-pricing its labor and overpaying for its external assets.

His worry is that when the Chinese government realizes the losses on its Dollar-denominated assets a new source of tension with the US will arise:

When the time comes for China to realize the losses that are now accumulating quietly on the PBoC’s balance sheet (and soon on the balance sheet of the state foreign investment company), I doubt China’s leaders will say, “you know, these losses were really incurred years ago, when we decided to sink a lot of Chinese savings into depreciating dollars in order to encourage our export sector and make it attractive for foreign firms to locate investment in China. We shouldn’t blame the US for the fact that China’s investments in the US haven’t done well. We were the ones who over-paid for US assets."

N.B.: "Yuan" and "Renminbi" (RMB) both refer to the same thing - the renminbi is China's currency, and the Yuan is the unit of account; and PBoC is the "People's Bank of China", their central bank.