Dissecting trends in Chinese dollar holdings

FINANCE AND ECONOMICS: "Economics focus: Not quite so SAFE; Is China souring on the dollar?" The Economist, 25 April 2009.

Great piece that leverages Brad Setser's work.

China's reserves fall in Jan and Feb, triggering alarm. One congressman blows hard about China's canceling America's "credit card"--the sort of simplistic tripe you come to expect from congressmen (simultaneously misinforming and mongering fear).

Setser says China's official estimate of foreign reserves ($1.95T) is really more like $2.3T when hidden reserves are included, like that held by China Investment Corp (sovereign wealth fund).

Setser says China's total reserves rose by about $40B in first quarter, about 1/5th of the rise in the same period of 2008.

Confronted by this decline, one assumes China's appetite lessens.

Setser says there are other numbers to consider: China's current accounts deficit is bigger than last year. That plus FDI gives China a net inflow of roughly $100B. So where did the other $60B if not into reserves?

Setser says a lot of "hot money" flows out of China--speculative capital held by Chinese, and some of that money is still probably buying dollars, just through intermediaries. China has, for example, routinely accounted for roughly one-third of the dollars bought on London's markets.

Add in stuff like that and China's reserves, which were 80-20 dollars-euros a while back, are probably 70-30 today, which remains better than the rest of the world in terms of favoring dollars (the world stands at roughly 60% dollars, 30% euros and 10% rest--last numbers I saw).

The drop is explained by China's State Administration of Foreign Exchanges' decision to diversify its dollar holdings from Treasuries to other investments in the U.S. For example, from June 07 to June 08, China's equity holdings (stocks) tripled.

In short, it's less a loss of faith in the buck than the search for higher returns.

Conclusion:

What does this all add up to? China is trying to have it both ways. It wants to lessen its dollar exposure, but it also wants to hold down the yuan. The picture has been temporarily clouded by shifts in "hot capital" flows, but so long as China runs a large current-accounts surplus, its reserves will rise. In order to keep the yuan weak against the dollar, a large chunk of those reserves will end up in greenbacks. Beijing's appetite may not match Washington's growing need for cash. But China cannot sour on the dollar without letting its own currency rise.

Remember that when you hear bullshit scenarios on China selling us down the river.

When you peg your currency to the dollar, you peg yourself to America's future.

Comments

[William R. Cumming]

The dollar climbed on announcement of N. Korean nuke test. The stock market went up in December 1944 when the Battle of the Bulge became public in the US. Hey is this a great country or what? Perhaps boots on the ground all over S. Asia and E. Asia as the DEMS become the War Party.

How much ego and hubris drives the DEMS foreign policy? We know thinking and rational thought seems to skip the Republicans! Between now and Labor Day will have better insights into this Administration.