With pressure rising on both its foreign exchange reserves and its currency, China has chosen to let its reserves slip, at least for now.
For months, China's authorities have been faced with a choice between keeping the value of the yuan from sinking below the psychological floor of seven to the U.S. dollar or letting foreign reserves fall below the U.S. $3-trillion mark.
On Feb. 7, the choice became clear as the State Administration of Foreign Exchange (SAFE) announced that China's forex reserves had dropped to U.S. $2.99 trillion in January from U.S. $3.01 trillion the month before.
In a statement, SAFE said the loss resulted from "intervention to maintain equilibrium" in supporting the yuan's value.
Over the past year, the downward drag on the currency has contrasted sharply with government statements of confidence that the economy is meeting its targets with a steady and sustainable growth rate of 6.7 percent in 2016.
But after the reduction in reserves to levels last seen in 2011, state media alternated between giving assurances and acknowledging concerns.
"The persistent decline of China's forex reserves has caused widespread concern about the country's overall financial stability, as the diminishing stockpile, still the world's largest, is perceived as shielding the economy from currency and foreign trade volatility," the official Xinhua news agency said.
Mathematically, the monthly decrease of U.S. $12.3 billion represents a loss of just 0.4 percent of China's cash pool.
But psychologically, the seventh monthly decline in a row may matter more, despite official assurances to the contrary.
"Reserves of $3 trillion were claimed to be the psychological bottom line for investor confidence by some people, who thought dipping below that would cause investors to panic," the official English-language China Daily said.
The paper stressed that there was "no need to worry," arguing that "one should not artificially set a 'psychological limit' for China's foreign exchange reserves."
But the monthly dip was only a token of the 25-percent loss since China's forex reserves hit a high of $3.99 trillion in mid-2014.
Worldwide currency markets will be watching to see whether the support strategy continues after a high-level shakeup of China's economic positions announced Friday.
In advance of annual legislative meetings, the government said that Vice-Minister He Lifeng would replace retiring Xu Shaoshi as head of the National Development and Reform Commission (NDRC), the top planning agency.
Vice-Minister Zhong Shan was named to lead the Commerce Ministry after Gao Hucheng, 66, steps down, state media said.
And Guo Shuqing resigned as governor of coastal Shandong province to succeed Shang Fulin as chairman of the China Banking Regulatory Commission (CBRC).
The impact on exchange rate policy remained unclear. So far, People's Bank of China (PBOC) Governor Zhou Xiaochuan, 69, has remained in his post.
Only two to three years ago, China's worry was about keeping speculative "hot money" out of the country in anticipation that the yuan would appreciate against the dollar.
But with weakening economic growth and the recovery of the U.S. economy, China's concern has been to curb capital outflows from chasing the stronger dollar and rising interest rates in the United States.
Last year, the yuan depreciated by about 6.5 percent, reaching a low of 6.96 to the dollar in December, perilously close to the "psychological limit."
In January, the currency rose by about 1 percent as the dollar weakened with uncertainties over U.S. policies and the pace of rate hikes. The yuan finished last week slightly stronger at 6.86 to the dollar.
But the combination of economic and political pressures on China has given rise to a debate over which measure of the country's financial stability needs more defending.
"The foreign exchange regulators realized they cannot disregard market talk on the U.S. $3-trillion level, so they quickly sent messages to the market to dispel these concerns," Xie Yaxuan, head of research at China Merchants Securities, told the South China Morning Post.
But others argued that the yuan's value should take precedence over reserve concerns, the paper said.
"A stable yuan exchange rate is currently the most important policy target for China," said Shen Jianguang, chief economist at Mizuho Securities Asia.
Worst of both worlds
Still others saw the choice as the worst of both worlds.
Some analysts fear that falling reserves could trigger a deep devaluation of the currency and a further stiffening of capital controls, Reuters reported.
"With FX reserves below $3 trillion, we can expect capital controls as well as tightening yuan liquidity to continue, as the authorities try to avoid a further drawdown," said Chester Liaw, an economist at Forecast Pte Ltd. in Singapore, according to Reuters.
In the end, the choice to defend the currency or the reserves against the psychological limits may matter little, since confidence in China is likely to suffer either way, said Gary Hufbauer, senior fellow at the Peterson Institute for International Economics in Washington.
China's choice seems to have been guided by a political decision to reduce the risk that the administration of President Donald Trump might charge it with currency manipulation if the yuan weakens further.
"I think it was partly influenced by hopes of arresting a U.S. decision that China is a currency manipulator," Hufbauer said. "That may have been underlying the decision, but I'm sure it was a hard one for the authorities to make."
During the recent U.S. presidential campaign, then-candidate Trump accused China of deliberately lowering the yuan's value to gain an unfair advantage for its exports. Trump threatened to retaliate with high tariffs on Chinese goods.
Some experts have warned that new across-the-board tariffs could touch off a trade war.
Waiting on report
Last week, U.S. Treasury Secretary Steven Mnuchin told Bloomberg News that there would be no announcement of a decision on the currency manipulation question before a scheduled report from the department in April.
On Feb. 14, The Wall Street Journal reported that the Trump administration is examining a possible alternative that would define currency manipulation by any country as an unfair subsidy.
Such a move could open the door for anti-subsidy claims by individual companies without singling out China, the paper reported.
In a reaction to the report, China's Foreign Ministry spokesman Geng Shuang denied that the country has ever undervalued the yuan to gain an export advantage.
China will continue to reform its rate setting procedures for the currency, Geng said in a China Daily report.
How long China can afford to spend down its reserves is a matter of debate.
Although the stockpile remains substantial, the level is gradually approaching the minimum level of U.S. $2.6-2.8 trillion that China needs to maintain confidence that it can cover its imports and debt service, according to International Monetary Fund methodology cited by Reuters.
Chinese economists have argued that adequacy can be maintained at lower reserve levels.
The currency concerns have already led to a tightening of China's capital controls.
In January, the government ordered tougher restrictions for individuals using their annual foreign exchange quotas to purchase up to $50,000 of U.S. currency.
But the new rules may have actually motivated some citizens to make conversions into dollars, China Daily reported, suggesting that some fear even tighter limits ahead.
'No going back'
On Feb. 13, SAFE Director Pan Gongsheng told China Business News that the country "will not return to its old path of capital controls or go backwards on its foreign exchange management policies."
But the pledge may be a matter of interpretation.
China will "enhance the scrutiny of forex transactions' authenticity and regularity, intensify the crackdown on irregularities, and ensure the healthy development of forex markets," Xinhua quoted Pan as saying.
The new limits on individual exchanges of yuan into dollars follows a SAFE statement last year that authorities were "closely monitoring the tendency of 'irrational' overseas investment in some areas," including real estate, hotels, and sports.
The investments are suspected as schemes to get cash out of the country and into safer dollars, further eroding China's reserves and undermining the yuan.
The higher bar for capital outflows has already had a major impact on China's outbound direct investment (ODI), which plunged 35.7 percent in January after climbing 44 percent in 2016.
Pan cited a "blindness in outbound investment" and urged a focus on investing in areas of China's strategic initiatives, including the "One Belt, One Road" (OBOR) program for foreign trade development and international industrial cooperation.