August 12, 2007
China, Reserve Accumulation, and (Further) Threats to Financial Stability
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.
Posted by Menzie Chinn at August 12, 2007 10:21 AMdigg this | reddit
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Tracked on August 13, 2007 06:12 PM
The term "balance of terror" as applied to finance is, in my opinion, simply wrong.
In the Cold War, the US and the USSR knew that if one missile was launched, it would almost certainly trigger a devastating response and counter-response, leading to the destruction of both countries.
But China is a creditor holding large reserves and the US is a debtor, desperately in need of cash to finance a poorly-managed "war." China might suffer some damage to its reserve position, but it is highly unlikely to suffer economic devastation.
Yes, China will have to stimulate internal demand to absorb its newly-formed productive capacity. But it should have been doing that all along.
There is no "balance of terror." There is the strong likelihood that American hegemony is ending, due to fiscal mismanagement, and the moderate likelihood that the rest of the world, including China, will have to grow a little slower.
Posted by: Charles at August 12, 2007 12:21 PM
The danger is that the current balance is a metastable situation. Like a ball balanced on top of a hill, a slight shove can send it rolling to the bottom. It is easy to imagine some otherwise innocuous incident causing a rush for the exits as everyone tries to cash in their rapidly declining investment in US Treasuries.
Posted by: Joseph at August 12, 2007 02:31 PM
Right on, Charles. Not only a misleading term, but a conveniently misleading one, though not as bad as the whole BW2 business. As you imply, if we ask what kinds of adjustments are required to exit the arrangement, it's clear that the US has a harder one, economically and politically--even if we take into account the differing sizes of the economies.
Posted by: Jim M at August 12, 2007 06:53 PM
China is doing 20 million housing starts a year last time I looked, data is hard to find. I hardly feel that is demand that needs stimulating.
In my very humble, amateur opinion, Chinese domestic demand is a major driver of global economic growth, and I am more worried about a slowdown in China tha in the USA.
Posted by: David Leitch at August 12, 2007 08:03 PM
You raise an interesting question, David, namely what is the relative GDP involved in export vs. internal consumption.
There's a huge difference between the GDP according to official exchange rate and the GDP according to purchasing power parity. If one takes the PPP as valid, then exports to the US are neglible, something like 2% of the economy. If one uses the official exchange rate, it's more like 10%. The Chinese are certainly acting as though exports are vital, but that may be more because they help to raise employment.
So, you may be right, that they don't need to stimulate internal consumption per se. But my impression is that most people still suffer significant deficiencies, both in material terms and in leisure. China would probably benefit from reducing overall growth somewhat, especially by devoting resources to environmental remediation, public sector investment, and improved work conditions.
Posted by: Charles at August 12, 2007 10:04 PM
...all China needs to do to make U.S. interest rates jump (further) up is to stop accumulating dollar assets.
I totally agree. All the pundits who were beating their chests about China holding US paper and the possibility of them forcing an economic crisis in the US is overly foolish. The Chinese would have a better chance of damaging the US if they just started launching missiles at LA.
Your comment is so prescient that it should shut down all the foolish talk, but it probably won't. Thanks for this reasonable post in the midst of unreason.
Posted by: DickF at August 14, 2007 04:29 AM