China has long suspected the US would eventually run the dollar printing presses overtime to get out of its financial hole, creating a dilemma for Beijing's large dollar reserves. The frustration in Beijing over America's policy is best illustrated by comments from the director of China's Banking Regulatory Commission, who told a New York audience: "We hate you guys Except for US treasuries, what can you hold?"
Chinese officials have made it abundantly clear they do not want to see Washington spark inflation and lower the value of China's dollar holdings. Likewise, Beijing worries that Washington's increasing stakes in companies might further dilute shareholder equity in certain firms. Wen Jiabao, the prime minister, went public earlier this year with blunt concerns over the security of Chinese investments in the US. Calls by the governor of the country's central bank, the People's Bank of China, for a new world reserve currency add to global uncertainties over the status of the dollar.
Beijing, having long been subject to exhortations from the US over the need to revalue its currency, to rebalance its economy and to open up its financial system to US banks (the same ones that have wrought global financial destruction), feels it is on firm ground in dispensing advice over how Washington conducts macroeconomic adjustments that have an impact on China's bottom line. But China's more assertive critiques do not amount to an imminent and radical departure from its current foreign exchange management policy. And this is despite a strategy that the State Administration of Foreign Exchange (SAFE) put in place last year to step up efforts to diversify China's foreign exchange reserves. This is only meant to reduce the proportion of its holdings denominated in dollars, estimated at about US$1 trillion (Dh3.67tn).
For several years, China had little success in meeting its goal of reducing the dollar portion of its reserves, given the sheer scale of dollar inflows through the trade accounts. That is beginning to change: for two straight quarters, China reduced its overall percentage of dollar assets, and in the final quarter of last year its euro holdings increased by more than dollar acquisitions. It is also steadily increasing its holdings of other foreign currencies.
The recent slew of overseas investments in natural resources companies is an additional element of this strategy, with Beijing permitting state-owned companies to use foreign currency reserves to support overseas investments. Outbound Chinese investments are likely to continue. Nevertheless, SAFE is in no rush to dump dollars. Indeed, given that SAFE's equity holdings have taken a serious hit, Beijing has followed many in the well-worn flight to the safety of short-term US treasuries. For the Chinese, the resulting dollar strength (viewed on a year-on-year basis; more recently, the dollar has weakened) created trade-weighted yuan depreciation that eases pressure on Chinese exporters. Beijing, for now, is perfectly happy to maintain a de facto dollar peg. For SAFE, meanwhile, the US Federal Reserve's moves boosted the market price of China's existing long-term treasuries. Beijing has little interest in rocking the boat. These bonds are attractive, given that short-term interest rates are near zero.
Perhaps more significant than Beijing's efforts to diversify its dollar holdings is the reality that China is likely to have a smaller volume of new foreign exchange reserves to invest overseas in any market this year. As global trade collapses, its trade surplus is shrinking. Even though Beijing is attempting gradually to diversify away from its dollar holdings, more sweeping moves to replace the dollar's hegemony at the heart of the global monetary system are neither imminent nor practicable. The central bank governor's remarks on the potential for a new monetary architecture based on an IMF-led management of special drawing rights served two purposes. First, it was an attempt to signal to domestic critics, who are unhappy about China's large dollar holdings, that the government is aware of the need to reduce its reliance on the dollar in the long term, particularly as the Fed monetises its debt. Next, China was showing an international audience that it remains open to co-operation within international financial institutions, provided Beijing is able to gain greater influence within those organisations.
At the summit meeting of the Group of 20 leading and emerging economies in London last month, China pledged $40 billion to the IMF and signalled a desire for a more prominent voice in the IMF in the form of larger voting rights. Currently, China has the same voting rights as Switzerland. In the meantime, though, and until a long-term shift out of the dollar is made that does not reduce the value of the dollar in international markets, Chinese officials will continue to mull over novel plans to reduce their dollar dependency.
The latest idea being mooted is the announcement that Brazil and China will work towards using their own currencies, rather than the dollar, in bilateral trade transactions. This might serve both countries' needs, but it is doubtful if the scheme can be widened enough to encompass bilateral payments with economies with weaker currencies. Until then, China, along with other trade-surplus countries, is stuck with the dollar.
Dr Mohamed A Ramady, a former banker, is currently a visiting associate professor in the finance and economics department at King Fahd University of Petroleum and Minerals, Dhahran, Saudi Arabia