Interpreting the signals from the Beijing mandarins is closely akin to reading tea leaves at the bottom of a mineshaft, buried in ten feet of mud, while wearing a blindfold. But The Financial Times think they’ve struck prophesy in a statement from China’s State Administration of Foreign Exchange (SAFE), headed by the recently appointed female Director, and Deputy Governor of the People’s Bank of China (PBC), Hu Xiaolian.
In a brief statement on its website, the government’s foreign exchange regulator said one of its targets for 2006 was to “improve the operation and management of foreign exchange reserves and to actively explore more effective ways to utilise reserve assets”.
It went on: “[The objective is] to improve the currency structure and asset structure of our foreign exchange reserves, and to continue to expand the investment area of reserves.
Now what in the world could this fortune cookie mean? Well it could be read to mean that China is intending to diversify their reserve holdings away from the US dollar, which according to most economists make up about 70% of total holdings, but which in my opinion is probably even a bit north of that.
Now this massive hoarding of dollar assets has been instrumental in financing the US current account deficit, keeping interest rates down, and probably one of the main factors in the recent inversion of the yield curve.
A Chinese diversification, if it indeed materialises, would of course put downward pressure on the dollar, which has shown some signs of faltering lately, after having had a good last year, paradoxically partly due to higher oil prices, as the sheiks largely parked their surpluses in US debt instruments.
Such a move would be bearish for the dollar. But while a falling currency carries with it a number of problems and risks (the trade deficit would for example widen, at least in the short term, as more green paper would have to be exchanged for all foreign imports, such as oil), it would make life easier for the US export industry. It wouldn’t be half bad for a government up to its gums in dollar denominated debt either.
The Powers That Be in Washington have been on Beijing’s back for quite a while now, trying to convince them to stop intervening in the currency market to prop up the dollar versus their own currency, the yuan/renmimbi. So far it’s been met with run-arounds and smoke and mirrors and an unpegging from the dollar in favour of pegging the yuan to a basket of currencies, which seems to consist of… 98% dollars. But this might be about to change.
The statement comes at a time of growing debate in China on how the reserves are invested. Some economists have called on Beijing to use the funds to finance infrastructure investment and clean up state-owned companies, or to invest in higher-yielding assets rather than financing US borrowing.
However, according to Stephen Green, economist for Standard Chartered in Shanghai, although the language was “vague”, Thursday’s statement was the first time Safe has publicly indicated a shift away from dollar assets.
“It is a subtle but clear signal that they are interested in moving away from the US dollar into other currencies, and are interested in setting up some kind of strategic commodity fund, maybe just for oil, but maybe for other commodities,” he said.
This would also chime with recent Chinese moves to loosen restrictions on market trading of the yuan, as recently reported in The Wall Street Journal (subscription required):
BEIJING — China will allow the yuan to be traded over the counter for interbank spot forex trading starting Wednesday, the country’s central bank said Tuesday.
China will publish yuan benchmark rates each trading day versus the U.S. dollar, euro, Japanese yen, and Hong Kong dollar, the People’s Bank of China said in a statement on its Web site.
The new trading system is another step toward giving market forces a larger role in determining the value of the yuan, and making the market for the currency more flexible.
This article is also available at Bitsofnews.com and Daily Kos.
China has been seeking alternatives to the dollar at least since last summer. They are trying to get out from under, so that when the dollar collapses they don’t go down with it.
But they have been pretty quiet about it. If they are ready to make a public announcement, I would have to assume the consider themselves at least partway there. Maybe out of the woods.
But as the dollar declines, China will have to move some its production away from export to the US. Where will it go? They have to export in order to buy the oil they need. I don’t know how much progress they have made on this, but they must have some sort of plan, to be ready and willing to make the website announcement.
For the dollar decline to benefit US exports–scratch that–for the dollar decline to benefit the US through exports, the US would have to have a robust and ready export industry. I cannot imagine what it would be. Our most steady export industry, agriculture, will benefit, except that this will be countered by the high price of oil. Allowing New Orleans to be destroyed has not helped either: Export agriculture really depends on a convenient seaport, and now they don’t have one. At best I expect they will tread water.
Well, yes, this year the dollar will (continue to) decline. That is probably bad for us, but that is not the worry. The worry is that the dollar will crash. A crash seems very likely. Sometime within the next two years. Of course Bushco is trying desperately to keep the slide from turning into a crash before the ’06 elections. After that who cares? They know it is inevitable, anyway. Do you think Bushco will succeed in staving off the crash that long?
Thanks for finding this.
Yes, I am indeed more skeptical on the balming effects of even the controlled inflation they (meaning the Federal Reserve and the Administration) are trying to engineer than I made any mention of in the article.
As you say, for the export sector to benefit in a big enough way for it to offset the negatives of a dollar decline, there would have to be a vital export industry, and capital looking to invest in it. I just don’t see that. In fact, I think the Chinese, and other Asian countries, could allow a sizable appreciation of their currencies at this time, and still grow their exports faster than the US.
Alexander, thank you for this post. I had found this article today on the subject and have been on the lookout for someone to post about it. Could this have anything to do with Iran’s plan to open their own Iranian Oil Bourse this spring? The plan is to trade for oil using the euro, not the dollar. Wouldn’t that put a crimp in the US’ ability to keep getting unlimited credit around the world and lead to instability of the dollar down the road? I hear that Russia and Venezuela are interested right from the get go, and China is thinking about it.
I am the last person to give opinions about economics, but this sounds troublesome even to my uneducated ears.
I’m not sure the Iranian oil bourse will amount to much, atleast in the short run. And I’m not sure the Chinese do either, but they are of course too polite to tell the Iranians that. Oh they’ll dabble, to please Iran, and to test the waters, in case it really did take off.
No, I think this has far more to do with simply trying to safeguard that some fraction at least of the reserve holdings will be safe from the ever more dubious looking dollar. It has to be done with finessse, as any wrong move on a huge reserve holder like China’s part, and they could prematurely set off the very avelanche that could wipe out a large chunk of the value of their holdings, before they got to stash some of it in diversified assets.
Personally, Nag I think you have hit the nail on the head. I think the euro is the problem for this administration. I had read that Iraq was going to do that exact thing, right before this administration went to get in this war with this country. This is not the first time I have heard this discussion on this topic this way. I first ran across it early last year. So if the saying that two years is correct, then we are at our end of things here.
I seriously doubt that this country can hold on much longer. Bush and his financial sector has run its gambit, as I see it. They no longer can do much of anything to secure things for us in the long run let alone the short run of things. I think, personally and I don’t understand much on the financial markets of things, that we have been snookered and we are sitting by idly as this is done to us without any help from our government. They are the problem in the first place. In the constitution, it is against the constitution for the president to bankrupt the country, of which he is doing. For this he can be impeached and further more he can go to jail for this one. Am I not correct here folks. I could stand to be corrected. Like I said I am not an expert
ECONOMIC FORECAST, 2006
Upswings and downfalls
I think we miss the boat when we concentrate on the monetary impacts of China’s ownership of the Bush debt. The political fallout is potentially much a threat to our standard of living and way of life. Bush has made the US the world’s largest debtor naiton, something his idol Ronnie Reagan also did. What is dangerous is that now China holds most of our paper, not Great Britain and China has huge leverage over us because of that that it can use to accomplish its political ends. What does George II do when the Chinese decide that now is the time to make Taiwan the next province? He will do what he always does: rattle a sabre and kiss ass to those with the money. It’s a nice result for the keep us safer president to have given up our sovereignty to China. Nice job George.
Don’t forget that Reagan/Bush sold us to the Japanese. It was upsetting to watch. But now look at them.
Ringing up a debt like we have means one thing: we aren’t planning on repaying it. We plan on whacking the loan shark. This one of several roads Bush has steered us down that have no return lane. He’s started fires in the Middle East, East Asia, Central Asia, Latin America and China that can’t be put out without war and destruction. He really is a sicko, but these deeds are done. The only way out for Americans is to eventually suffer the hangover for his partying ways.
War with China by 2015. That major war will start during our campaign for SE Asian Oil (East Timor or Indonesia probably), which will follow our campaigns for West African and Latin American Oil. We may secure LA and WA oil through proxy wars, etc, but China is the Big One and for those who think “Murtha speaks for me” should be aware that he doesn’t even want to wait until 2015.
I am a pacificist, but even I see that it is unlikely that my grandchildren won’t be speaking Mandarin and Spanish on top of a few English phrases if we don’t eventually go to War with China. I personally like Chinese art and food better, since we are now also a police state anyhow, would their rule be so bad? China takes over by assimilation, and owning our financial asses is a great start.
Or we can go to war with them and the question is simply, ‘When?’ If you accept the war scenario, Murtha is right to want to push us to the brink with China, as Grant was with Russia. I mean better now than against a much more powerful version of China, right?
Powee! This is gonna rule. Oh, by the way, tax day is April 15th. Be sure to belly up your part of the tab for the wholesale destruction of the world as we wish it was.