From Financial Times:
China affirms dollar’s global reserve status
By Richard McGregor in Beijing
Published: August 12 2007 17:39 | Last updated: August 12 2007 17:39
Beijing on Sunday sought to repair fallout from reports it could use its $1,330 bn foreign exchange holdings to put pressure on Washington and the dollar with a statement affirming the importance of the US dollar as a global reserve currency.
The official Xinhua news service quoted an anonymous official at the People’s Bank of China, the central bank, as saying that China was “a responsible investor in the international capital markets”.
“US dollar assets, including American government bonds, are an important component of China’s foreign exchange reserves, as the dollar enjoys a major position in the international monetary system, based on the large capacity and high liquidity of US financial markets,” the official was quoted as saying. “The close economic and trade relations between China and the United States play an important role in the stable development of the two countries’ economies and the world economy as well.”
The statement followed an article last week by the London-based Daily Telegraph, asserting Beijing had launched a “concerted campaign” of economic threats against Washington, with hints it could “liquidate” US dollar holdings.
The story was initially dismissed in China but prompted testy responses from US President George W. Bush and Hank Paulson, the US treasury secretary.
The article was based on the published comments of two members of government economic research institutes, He Fan and Xia Bin.
But Mr He, a Harvard-educated economist, said his views, about how an appreciating renminbi could force China to sell US dollars, had been “misrepresented”.
Mr Xia, a well-known maverick, said in a recent speech China’s reserves could be used as a “bargaining chip” with the US.
Andy Rothman, of CLSA, the brokerage, in Shanghai, said any Chinese sell-off of dollar assets was unlikely as it would rebound on China’s substantial holdings of US Treasuries.
Mr Rothman said: “If they started selling a significant portion, the market would react and the value of the rest of China’s Treasuries … would quickly plummet.”
China’s own state investment fund and government companies are also now attempting to invest large sums overseas and any politically motivated sell-off by Beijing of its foreign currency holdings would undermine that drive.
The central bank official restated longstanding policy that government priorities in reserve management were, in order, security, liquidity and investment returns.
Two observations on this topic (very much related to Brad Setser’s post on the ‘financial balance of terror’):
- First, in Saturday’s Washington Post article, I was quoted as saying that this particular threat was not credible. Now, what was not included in the article was my contention that we could end up in a situation — perhaps through miscalculation — where China did end up with a lower value of dollar reserves, either because they ended up in a conflict where they tried to dump dollar assets, or the value of dollar assets declined.
- Second, all China needs to do to make U.S. interest rates jump (further) up is to stop accumulating dollar assets. No dumping is necessary, given the fact the U.S. still has an outsized current account deficit — constituting a large share of the the rest-of-world’s offsetting surplus — to finance. Of course, this is harder than it sounds, given the fact that most trade is invoiced in dollars. But, what this means is the threshold for inducing turmoil is less than one might think, even if one thinks the Chinese have little incentive to drive down the dollar’s value.