Progress Pond

Is China Backing away from the Dollar?

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.

0 0 votes
Article Rating
Exit mobile version