US bonds still comprise a major share of Chinese foreign
reserves. Currently, China's foreign reserves have surpassed US$1.2
trillion, the largest number in the world. About 70 percent of
these reserves are dollar assets, including high liquidity US
bonds, securities and corporate bonds.
People are becoming increasingly uneasy about reports saying
China is reducing its holdings of US bonds. Currently, China is the
second largest holder of US bonds, retaining 10 percent of all
tradable bonds of the United States. Some analysts fear that
China's new moves to reduce this number will drag the US bond
market down and further weaken the dollar.
Worry first came from the US Department of Treasury in June.
Statistics showed by the end of April this year, China held US$414
billion in US bonds, US$5.8 billion less than they held by the end
of March. Total tradable US bonds are worth around US$4.4
trillion.
Analysts argue that China has continuously been increasing its
holdings of US bonds before this downtrend. Yet the rare move may
possibly indicate a new trend towards shedding some of the
excessive holdings.
The case is reminiscent of another event coming on November 25,
2004. On that day, Yu Yongding, then member of the Monetary Policy
Committee under the People's Bank of China, mentioned that of all
Chinese foreign reserves, dollar assets had decreased. Two days
after his speech, the US bond market suffered a major decrease.
Therefore, recent reports of shrinkage in holdings have caught
the attention of the US Department of Treasury. US Treasury
Secretary Henry Paulson, Chairman of the US Federal Reserve Ben
Bernanke, and his predecessor Alan Greenspan all recently publicly
stated that the reduction of the US bond holdings by foreign
countries should not pose a threat to US economic security. They
argued that China only holds the one-day trading amount of all the
US government bonds combined.
As a matter of fact, China isn't currently intent on cutting its
holdings of US bonds.
Market forces hand
Liu Fuxiang, Professor with the University of International
Business and Economics, noted that China's move is normal and is in
line with market operation principles.
Liu said that the dollar has been weakening and depreciating,
thus dollar assets no longer enjoy the same attraction as they used
to. In order to save the country from losing money, China is smart
to sell off some of the US bonds.
Liu's view is echoed by Zhong Wei, financial professor with
Beijing Normal University. Zhong said that Chinese foreign exchange
rate reform has led to mild appreciation of the yuan against the
dollar, thus reducing the necessity of dollar assets. The reason
for cutting US bonds is that interest rate trends in the middle-
and long-term for US bonds are unpredictable and uncertain.
Currently, most Chinese foreign reserves are dollar assets. If the
dollar depreciates greatly, China will suffer huge losses.
In fact, China is not alone. British and Russian central banks
have shown similar concern.
Statistics from the US Department of Treasury show that Britain
reduced its holdings of US bonds by US$12.4 billion in April, the
biggest cut of all countries.
In general, world investors were selling US bonds in April. By
the end of April, countries outside the United States held US$2.17
trillion, down US$28.2 billion from the end of March.
Xie Guozhong, former chief economist with Morgan Stanley China,
contended that China's April move was caused by the change in
expectations over yields of the US bonds and because of the US
inflation rate.
Since 2002 the dollar has depreciated 15 percent. In April, the
US bond market depreciated US$555 billion, forcing US bond holders
to sell.
Moreover, the Chinese central bank also has to trade foreign
reserves to maintain the renminbi exchange rate in order to keep it
floating within a reasonable range, and shedding US bonds, which
take the biggest share in China's foreign reserves, becomes the
first choice for maintaining this level.
Optimizing foreign reserve structure
The US$5.8 billion in US bonds China shed are just a small sum,
but it reflects a fact that the Chinese central bank is consciously
optimizing its foreign reserve structure.
Currently, China's foreign reserves have surpassed US$1.2
trillion, the largest number in the world. About 70 percent of
these reserves are dollar assets, including high liquidity US
bonds, securities and corporate bonds. About 20 percent of the
reserves are euro assets and the final 10 percent are made up of
currency assets such as the Japanese yen and the South Korean
won.
Judging by the foreign reserve structure, dollar assets make up
the largest proportion. China's bulk purchase of US dollar bonds
provides financial support for the US treasury deficit and helps
maintain US interest rates at relatively low levels.
Current trends show that in the next few years, Chinese foreign
reserves will increase steadily. With renminbi appreciation the US
dollar will depreciate. This means the value of China's dollar
reserves will decrease significantly. Therefore, China must change
its foreign reserve structure before losing out.
"Dollar assets should make up about 60 percent of all Chinese
foreign reserves," said Liu.
Two years ago, China planned to diversify its foreign reserve
structure.
On May 31 this year, the vice governor of the Chinese central
bank Wu Xiaoling stated clearly that China didn't mean to reduce
the dollar assets in its foreign reserves, but that the importance
of the euro as a reserve currency is certainly on the rise.
The Chinese central bank is also considering whether or not it
would like to increase the proportion of its holdings of Japanese
yen and gold. Meanwhile, China is investing its US assets to reduce
losses caused by the dollar depreciation.
China is planning to set up a national foreign reserve
investment company that will manage US$200 billion of the Chinese
foreign reserves. While not yet officially established, the company
has already taken some action. In May it invested US$3 billion in
the biggest US private equity firm-the Blackstone Group.
In 2006, the State Administration of Foreign Exchange canceled
restrictions on Chinese investment abroad and said it intends to
support domestic companies as they begin to invest overseas.
Before, domestic companies could only invest at most US$5 billion
abroad each year and they had to get approval from the supervisory
department if their purchase of foreign reserves surmounted US$10
million.
"Those measures didn't reduce the dollar assets, but will reduce
its proportion in the Chinese foreign reserves," said Liu.
No abrupt reduction
Professor Liu said that in order to optimize foreign reserves,
China will proceed in a stable, safe and floating manner. That
means diversification of the foreign reserve structure will be a
gradual process and China won't cut its US bonds substantially.
Tan Yaling, senior researcher with the Bank of China, agreed
with Liu's opinion. She said that US bonds are still one of the
most stable investment objectives, as "the US economy is far better
than that of other countries."
Tan contended that compared with the United States, the economic
structures of the European Union and Japan are relatively weak and
are less mature and steady. As a result, currency stability of
those countries is not as strong.
He Fan, a research fellow with the Chinese Academy of Social
Sciences, said China's stance in regard to holding US bonds is a
great concern of the global financial market, thus China is faced
with a conundrum: US dollars are undergoing a depreciating trend,
and if China sells the US bonds in large amounts, the dollar will
further depreciate substantially, leading to a plunge in the value
of Chinese foreign reserves. However, if the US economy is in
trouble, the Chinese economy will also suffer because the United
States is the biggest export destination of China.
He said it seems necessary to reduce the proportion of dollar
assets as other currencies appreciate. But in effect, China doesn't
want to see the chain reaction caused by a large-scale sale of US
bonds. For instance, selling bonds will help increase the US
interest rate and the cost of loans, which will result in a slump
in consumption. The consumption slump will reduce US imports from
other countries, thus exporting companies of other
countries-especially China-will be hurt enormously. In the end,
China's economy will suffer.
The United States is the most powerful country in the world and
its status as such will continue over a long period of time.
Whatever currency-euro or yen-cannot challenge the dollar's
dominant status. No other economies are as attractive as the
economy of the United States. When China-US trade relations deepen
and political cooperation grows stronger, China will never and
should not ignore the long-term value of dollar assets.
Tao Dong, chief economist of Asia-Pacific region with Credit
Swiss First Boston, stated confidently that "China won't sell
dollars as people fear and it will continue to buy dollar assets
this year."
(Beijing Review July 12, 2007)
