China's US holdings ‘normal'

The specter of <?xml:namespace prefix = st1 ns = "urn:schemas-microsoft-com:office:smarttags" />China as banker for the US and the prospect of Beijing dumping its vast holdings of US government debt is thought to keep some US congressmen awake at night.<?xml:namespace prefix = o ns = "urn:schemas-microsoft-com:office:office" />

They are unlikely to be convinced by yesterday's comments from Yi Gang, the man in charge of China's foreign exchange reserves that China does not wish to politicise its holdings of US Treasuries.

There was muted reaction in Washington where the Treasury department would not immediately comment.

”Most people in the US Treasury would subscribe to the view that the Chinese don't have much choice,” said Nicholas Lardy of the Peterson Institute for International Economics, a Washington think-tank. “So they probably won't give them too much credit for this announcement.

“For those who think China doesn't have much leeway to diversify, this just states the obvious.” He added, however, that “on the margins” this could make the US Treasury less likely to cite China as a currency manipulator in a report expected next month. According to most analysts and government officials in both countries, China does not really have the option of wielding foreign exchange purchases as a weapon in bilateral relations.

“China can diversify a bit on the margins but when it comes to investing the $30bn-$40bn a month Beijing is accumulating in foreign exchange reserves, there are only two markets deep and liquid enough – the US and eurozone government bond markets,” according to Stephen Green, head of research in greater China for Standard Chartered Bank. “The euro market has shown brilliantly in recent months that it is not exactly risk-free.”

The prospect of China dumping dollars caused a flurry of excitement last month when the US Treasury published preliminary data showing that China cut its holdings of Treasuries by $34.2bn in December. Total holdings, according to revised figures, stood at $895bn at year end.

US monthly Treasury data is notoriously unreliable at showing exactly how much China or other countries are investing in US government bonds. One reason is that monthly surveys are unable to determine the ultimate buyer of Treasuries if they use third parties or subsidiaries in financial centres such as Hong Kong and London to make purchases.

China's State Administration of Foreign Exchange (Safe), which manages the country's $2,400bn in foreign exchange reserves, is known to route purchases through its offices in these two cities. Taking this into account, Standard Chartered estimates that China's US Treasury holdings actually stood at about $1,020bn at the end of 2009.

“Overall, it looks like China's US holdings, as a ratio of its total holdings, are still within the normal historical range” of about 68 per cent of its total reserves by the end of 2009, Mr Green said. “In other words, there has been no abnormal break with the dollar so far.”

For the past five years, Chinese financial officials have repeatedly made clear Beijing's intention to gradually diversify its holdings away from US dollar assets by reducing the proportion of such assets in its foreign exchange purchases. But analysts and officials such as Mr Yi point out that any rapid shift into another asset class, such as gold, would lead to soaring prices of that asset and could hurt China by decreasing the value of its own holdings.

“Over the medium term I think Safe would like to diversify away from one dominant asset class,” says Wang Tao, chief China economist at UBS. “But even if they want to diversify, they have to do it as inconspicuously as possible – otherwise others will move with them and they will be hurt as the largest holder of US Treasuries.”

Some analysts point out that thanks to higher US saving rates and a shrinking current account deficit, the overall proportion of US government debt held by domestic investors is rising and the proportion held *by countries such as China is shrinking, making any potential Chinese threat to dump dollars less frightening.

“China is sitting on a huge pile of dollars and the US economy is the only place big and solid enough to absorb it back,” said Derek Scissors, a research fellow at the conservative Heritage Foundation in Washington. “Any American financial dependence on China has almost vanished and the misconception that China is America's banker should vanish.”