The appreciation of RMB will not lead to the loss of the value of China's foreign exchange reserves, and China's wealth will not decrease.
One view is that if the RMB appreciates, China's huge foreign exchange reserves will depreciate. For example, RMB appreciation 10%, from 6.6 yuan to 6 yuan, China's RMB-denominated foreign exchange reserves decreased 10%, which reduced China's wealth. This view is correct in mathematics, but completely wrong in economics. China's wealth will not decrease with the appreciation of RMB.
This truth is most obvious when considering the impact of a country's currency depreciation. If the local currency depreciates, the value of foreign exchange reserves denominated in local currency will rise. The greater the depreciation, the greater the appreciation. According to the above logic, as long as a country holds foreign exchange assets, it can completely devalue its currency and become very rich. Of course, the devaluation of the local currency will not make a country richer, nor will the national wealth increase. Similarly, currency appreciation will not reduce a country's wealth. If you don't believe this, it is a misuse of the balance sheet accounting practices of monetary authorities (such as China Safe).
Why is the value of China's foreign exchange reserves lost, such as the decline in purchasing power? Basically, when China buys goods and services in the international market, it will be more expensive to price them in dollars. If the international price denominated in US dollars rises, the real value of China's US dollar reserves will also decline. In order to avoid this situation, China should pay attention to the overall global inflation, or at least pay attention to the rising prices of the goods and services it wants to buy most.
Holding foreign exchange reserves is an endogenous protection against general inflation, not the price increase of specific commodities. Foreign exchange reserves are mainly held in the form of interest-bearing securities, during which the interest rate of securities will reflect the inflation rate. Lenders are willing to lend only when interest rates can resist overall inflation. In other words, if inflation expectations rise, interest rates will also rise.
Therefore, the interest rate of foreign exchange reserves will be adjusted according to the expected inflation rate. The higher the inflation expectation, the higher the interest rate will be. Only when market participants encounter unexpected inflation will the real value of foreign exchange reserves be eroded. Recently, Britain and the United States issued inflation index bonds, and institutional investors can avoid the impact of sudden inflation by buying these bonds.
Analysts are worried about the loss of foreign exchange reserves, which may have a second meaning. For example, suppose that foreign exchange reserves are all dollars. If the dollar depreciates against the euro or the yen, the foreign exchange reserves denominated in the euro or the yen will lose their prices. This does happen from time to time when the world's major currencies fluctuate with each other. However, exchange rates usually move in more than one direction. When the dollar appreciates against the euro, the dollar reserves denominated in euros will increase.
Broadly speaking, when people are free to choose the unit of valuation, the value of all interest-bearing financial assets will decline unless they happen to hold the currency with the fastest appreciation. However, the currency with the fastest appreciation is always changing. Therefore, when pricing with this currency, in order to avoid losses, we must constantly adjust the composition of the currency used for reserves. In other words, financial managers must accurately predict which currency will appreciate the fastest and hold currency reserves.