People’s Bank of China Governor Zhou Xiaochuan announced at a
meeting of central bankers in Frankfurt this past Friday that his
nation plans to diversify its $1 trillion currency reserves. [1] Zhou
stated that China has a clear diversification plan that includes
“currencies, investment instruments, [and] emerging markets,” but does
not include the sale of any of its dollar denominated assets, which
make up approximately 70% of China’s total reserves. [2] Despite Zhou’s
assurances that China would not be selling off its dollar denominated
assets, the dollar fell to a two and a half month low against the Euro
and gold prices rose to a two month high. [3]
Many
analysts believe that China is unlikely to sell off a large amount of
its dollar denominated assets; as to do so would be against China’s
interests. [4] If China were to make such a sale, the sudden influx of
U.S. debt on the world market would cause the dollar to plummet,
devaluing the rest of China’s dollar denominated reserves. [5] Because
it is unrealistic for China to sell off a large amount of its dollar
denominated assets, many in the banking industry believe that the
dollar will not continue to fall. [6]
In fact, rather than dumping their dollar denominated reserves, most
central banks are switching from traditional treasury bills to higher
yield agency-debt, and securities issued by Freddie Mac and Fannie Mae,
the sale of which recently hit an all time high. [7] The Bank for
International Settlements reports that dollars accounted for 66% of
world-wide central bank reserves at the end of March, a small change
from 2001 when dollars accounted for 70% of reserves. [8]
The Chinese want to diversify their reserves in order to have
greater flexibility in their monetary policy. [9] Many analysts believe
that given China’s trade surplus the Yuan is undervalued. [10] The
Chinese want to adjust the Yuan’s exchange rate gradually because they
fear a rapid re-evaluation of the Yuan could lead to a serious
disruption of China’s internal economy that would result in
bankruptcies and unemployment. [11] China’s concern about destabilizing
its internal economy is good news for the U.S. as it means that China
is unlikely to make any dramatic changes in its reserve policy. While a
change in policy is bound to happen at some point, it will most likely
happen gradually over a long period ensuring that both the U.S. and
Chinese economies are not seriously disrupted.
[1] CNNMoney.com, Dollar Falls on China Diversification Talk, Nov. 10, 2006, http://money.cnn.com/2006/11/10/markets/dollar_china.reut/index.htm [hereinafter Dollar Falls].
[2] Simon Rabinovitch, Reserve Shift Taps Forex, emerging Markets: China, Yahoo.com, Nov. 10, 2006, http://news.yahoo.com/s/nm/20061110/bs_nm/economy_china_zhou_dc.
[3] Id.
[4] Matthew Benjamin & Christopher Anstey, Zhou Says China Will Diversify Reserves Without Dumping Dollars, Bloomberg.com, Nov. 10, 2006, http://www.bloomberg.com/apps/news?pid=20601068&sid=ad6Wgf9XLHiE&refer=economy.
[5] Rabinovitch, supra note 2; Id.
[6] Dollar Falls, supra note 1.
[7] Benjamin & Anstey, supra note 4.
[8] Id.
[9] Rabinovitch, supra note 2.
[10] Id.
[11] Id.