Thread: China and the Dollar

China, Greenspan rub salt
in dollar wound

The US dollar was struggling near a two-month low against the euro on Friday as the market braced for fresh trade data that were likely to show a further widening of the trade gap. As if this weren't trouble enough for the besieged greenback, US Federal Reserve chairman Alan Greenspan stirred up the market Thursday night saying foreign investors would reduce their US asset holdings at some point, while new findings came to light that China is indeed doing so.

Saying he is not "overly" concerned about the record US trade gap or heavy consumer debt, Greenspan said the budget deficit gives him the shivers. The US current account deficit widened to a record US$164.7 billion from July through September, the most recent figures available, equivalent to 5.6% of gross domestic product (GDP). "Our current account deficit and household debt burdens do not strike me as overly worrisome, but that is certainly not the case for our fiscal deficit," Greenspan told the Council on Foreign Relations in New York. "Our fiscal prospects are, in my judgment, a significant obstacle to long-term stability, because the budget deficit is not readily subject to correction by market forces that stabilize other imbalances."

According to the high priest of finance, international investors have only modestly shifted their portfolios away from dollar assets so far. But he warned that they might at some point decide their portfolios are too dollar-centric, ominously adding that if the dollar keeps dropping, foreign exporters may start looking elsewhere.

Greenspan's comments came close on the heels of Japanese Prime Minister Junichiro Koizumi's startling remark on Thursday that Japan needs to diversify its foreign-exchange reserves, reviving fears of Asian central banks cutting their giant dollar reserves. Any move by Japan, which has the largest foreign-exchange reserve in the world ($840 billion), to reduce its dollar holdings could be disastrous for the greenback. The dollar has already been dropping against the yen for four straight weeks now. Koizumi's statement, though later qualified by his finance minister, will only prolong the agony.

US dollars accounted for 63.8% of the world's currency reserves at the end of 2003, down from 66.9% two years earlier, according to International Monetary Fund (IMF) figures released last April. A survey this January commissioned by the Royal Bank of Scotland Plc and conducted by London-based Central Banking Publications Ltd showed that central banks across the world were boosting euro holdings. Almost 70% of the 56 central banks surveyed said they had increased exposure to the euro.

Citing a more recent finding, Asia Times Online reported on Thursday (Dollar catching Asian flu) that Asian central banks have been quietly switching their dollar holdings to regional currencies for at least three years now. A study by the Bank of International Settlements (BIS), which acts as a bank for the world's central banks, shows that the ratio of dollar deposits held in Asian offshore reserves declined to 67% in September, down from 81% in the third quarter of 2001. India was the biggest seller, reducing its dollar assets from 68% of total reserves to just 43%. China, which directly links the yuan to the dollar and is under US pressure to allow a freer movement of its currency, trimmed the dollar share from 83% to 68% over the same period.

Bloomberg reported on Friday that according to an estimate by Lehman Brothers Holdings Inc, China's central bank has been cutting the share of its currency reserves held in dollars and replenishing them with euros. Some 76% of China's reserves were in dollars last year, down from 82% in 2003, said Lehman, the fifth-largest US securities firm.

There has been debate in China on whether it at all needs such a huge foreign-exchange reserve. China's forex chief, Guo Shuqing, a member of the National Committee of the China Political Consultative Conference (CPCC) and director general of the State Administration for Foreign Exchange Management (SAFEM), said that as an item of international payments, the growth of the foreign-exchange reserve is the result of the macroeconomic operation, but not the objective China is particularly pursuing. An adequate foreign-exchange reserve is favorable for payment abilities, comprehensive national power and creditworthiness, reducing risks of reform and safeguarding financial security, he said.

Guo pointed out, however, that excessive growth could be detrimental. In a rare and stern warning against the inflow of speculative funds, or "hot money", in the name of investment, he told local governments not to lure foreign investment "haphazardly". Regulators have been playing down the amount and impact of hot money over the past year, but Guo said China might see "no end of trouble in the future" unless local governments are acutely aware of risk mitigation in soaking in foreign funds.

"China pays great attention to speculative funds," Guo said in an interview with Xinhua on the sidelines of the annual session of the National Committee of the Chinese People's Political Consultative Conference, China's top advisory body. "Foreign-exchange administration departments and other macroeconomic departments are investigating the issue and will punish illegal activities severely."

China's foreign-exchange reserve added as much as $206.7 billion last year alone. Guo said the overall inflow of capital is "normal and legal" and reflects the "market scenario", but there are also some "worrisome" problems. "Fake foreign investment" is actually being used to purchase yuan-denominated assets and commercial housing on speculative purpose, he noted. Hot money has pushed housing prices to a very high level, making cities look "prosperous" but doing no good to the investment climate, as it leads to higher living and business costs. Typically, this means great risks for local financial institutions, enterprises and even individuals. When the real-estate bubble bursts, they will suffer from huge losses, Guo said. Hot money has also sneaked into China under capital accounts or based on no real trade, he claimed.

Guo said China's foreign-exchange reserve, second only to Japan's, is quite enough to pay the country's debts. But its debts in foreign currency may snowball to an amount that engenders "systematic risks". He revealed that newly added foreign-exchange reserves last year include $60.6 billion in foreign direct investment, $32 billion in trade surplus, $30 billion from foreign-exchange clearing under the account of imports and exports by enterprises, $35 billion in foreign debts, more than $10 billion in service trade surplus, $30 billion in individual asset transfer and earnings being brought about, and more than $10 billion in securities investment, among others.

Mountains of foreign-exchange reserves have long been an excuse used by some countries, especially the United States, to demand appreciation of the yuan, which now floats against the US dollar within a narrow band. But Premier Wen Jiabao reiterated in his government work report last week that China would keep the yuan "basically stable".

http://www.atimes.com/atimes/Global_.../GC12Dj01.html