Currency Commentaries
China Losing Confidence in the Dollar
By Washington Post
Jan 10, 2006, 10:17

By Peter S. Goodman

Monday, January 9, 2006

SHANGHAI -- As China's industrial juggernaut has flooded foreign
ports with cheap factory-made goods in recent years, its central
bank coffers have filled with the bounty flowing back to these
shores -- a stash of foreign exchange now exceeding $800 billion.
China's leaders have steadily invested the bulk in one primary
vehicle: the U.S. dollar.

But on Monday came the latest recent sign that China has grown
worried about tying its savings so closely to the dollar, a currency
that many economists think is due for a fall. A senior economist at
China's State Council -- the equivalent of the cabinet -- said in an
interview that China is moving toward a new policy of buying fewer
U.S. Treasury bills while shifting slightly toward buying assets
that trade in other currencies.

China now boasts the world's second-largest stock of foreign
exchange reserves after Japan, and with roughly three-fourths of
those holdings now invested in the U.S. dollar and dollar-backed
assets such as bonds and real estate, even a slight shift in the
composition of China's investments could push the value of the
greenback down, some analysts said.

The comments of the senior economist, made on condition of anonymity
because he is not authorized to speak to the press, confirmed an
analysis in Monday's Shanghai Securities News stating that China is
inclined to shift some its savings into other currencies such as the
euro and the yen, or into major purchases of commodities such as oil
for a long-discussed strategic energy reserve.

In a report circulated this week, Stephen Green, senior economist
with Standard Chartered Bank in Shanghai, identified several signals
that China is intent on limiting its exposure to the dollar -- not
least, a recent pledge from the State Administration of Foreign
Exchange to "actively explore more efficient use of our foreign
exchange reserves."

"We believe this adds to the downside pressure [the U.S. dollar] is
currently facing," Green wrote. "It is the first official expression
from SAFE that they are looking at switching away" from the dollar.

The comments on SAFE's Web site reinforced earlier public warnings
from Yu Yongding, an economist on the monetary policy committee of
China's central bank, that the country's reserves are now vulnerable
to a drop in the value of the dollar.

"The general trend for the U.S. dollar is continuously weakening,"
Yu said, speaking to reporters on the sidelines of a conference in
Beijing last month. "Countries with huge foreign exchange reserves
will have their assets shrunken."

Last week Hu Xiaolian, director of the foreign exchange
administration, said China plans to "optimize the structure" of its
reserves. Analysts took that to mean China would pursue a higher
return that it can get from holding dollars by diversifying its
reserves.

Many economists anticipate a significant slide in the value of the
dollar if the United States' trade and fiscal deficits continue
growing. In recent years, the dollar has been propped up by
aggressive purchases by China, Japan and oil-exporting countries.
Some economists warn that this has made U.S. prosperity dependent on
the willingness of foreign powers to continue financing America's
profligate ways. If foreigners lose their appetite for U.S.
Treasuries, the dollar would drop, increasing the cost of imported
goods in the United States and likely forcing the U.S. Federal
Reserve to lift interest rates, perhaps bursting what is widely seen
as an investment bubble in the real estate market, sending prices
plummeting.

But some economists say this analysis is flawed: Were China and
Japan to engineer a significant fall in the dollar, those nations
would suffer the consequences -- sharply diminished exports as
American lose spending power, plus a drop in the value of their
dollar assets.

"It is thus extremely unlikely that China would do anything to harm
its own balance sheet," wrote Stephen Jen, an economist with Morgan
Stanley, in a research note distributed Monday.

China continues to amass foreign exchange reserves at a pace of
roughly $15 billion per month, a pace that would see it exceed $1
trillion later this year.

Warnings about an impending Chinese selloff in dollars emerged in
July, as China slightly altered the way it sets the value of its
currency, the yuan, bumping it up against the dollar by about 2
percent. At the time, China announced that it would gradually allow
greater movement in the exchange rate -- something that has yet to
materialize -- while also shifting from a system in which the yuan
moves with changes in the dollar to one where it tracks a basket of
currencies including the yen, the euro, the Hong Kong dollar and the
South Korean won.

The move temporarily muted criticism on Capitol Hill from those who
accuse China of currency manipulation, asserting that an
artificially low yuan has made China's goods unfairly cheap on world
markets. But as the implications of the new currency policy rippled
out, some analysts suggested that China would thereafter have less
need for dollars and greater need for the other currencies in the
new basket, sending the greenback down and risking higher U.S.
interest rates that would dampen economic growth.

China sought to quash such talk. In September, a senior central bank
official told a ballroom full of international executives gathered
in Beijing that China would not sell significant quantities of U.S.
bonds, cognizant that such a move would "cause the price to plunge."

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