Principle theme

19 August 2010

China: In dollar we distrust?

According to a US Treasury Department report, China has become the second-biggest world’s economy. Its GDP in the second quarter of this year amounted to 1 trillion 335 billion dollars. At the same time Chinese investments in US Treasury Bonds fell in June to 843.7 billion dollars, the lowest in the last 18 months. 

First it was short-term bonds, whose yields are now at the levels close to record-breaking minimums. Starting about a year ago China sold them to the tune of 72 billion, at the same time remaining the principal US creditor.

It has more than doubled South Korean debt holdings this year, as policy makers shifted part of the world’s largest foreign-exchange reserves out of dollars. 

Korean Treasury bonds held by Chinese investors rose 111 percent to $3.4 billion in the first half of the year. According to Ding Zhijie, a former adviser to China’s sovereign wealth fund, China should allocate some reserves to “financial assets in major Asian economies. 

At the same time Chinese financial authorities say that given annual per capita incomes last year, a little more than 3,500 dollars, absolute GDP indices fail to reflect the real amount of power Chinese economy has mustered. In Japan, for example, this index amounts to 37,000 dollars.

The 6% fall of China’s holdings of US Treasuries makes it harder for President Barack Obama to finance record debt sales to sustain the U.S. economic expansion. Korean Treasury Bills have handed investors a 5.6% return this year in dollar terms, delivering a profit every month, according to an index compiled by HSBC Holdings. 

Diversification should be the “basic principle” of reserve management, Yu Yongding, a former adviser to the People’s Bank of China, said in an interview this month. Allocations to dollars in official reserves fell in the first three months, to 61.5 percent from 62.2 percent in the final quarter of 2009, the International Monetary Fund said June 30. 

Nevertheless, China’s nominal GDP is growing at about 20 percent per year. Given such rates of China’s development that country is gaining more and more momentum on the global political arena, said Yaroslav Lisovolik, Chief Economist of Deutsche Bank.

“It has just been a matter of time, and China may become the world’s biggest economy one day – but not too fast. China is one of the most dynamically developing countries, gaining on the developed world quite fast from both the vantage point of its total GDP and per capita incomes. The role China is now playing in international organisations is growing following the weight of its economic growth, Yaroslav Lisovolik believes.

Even though China tries to become more self-efficient, it is strongly dependent on the US currency, which it just has to purchase. However, fear of its depreciation multiplied by the need to re-orient its industries to cater for the domestic market pushed the Chinese authorities to buy everything they can – for the very dollars. So far natural resources as an element of its new strategy of diversification of state-supported investments as a way of reducing dollar risks, appear to be most attractive to China. It is wary of the potential growth of inflation spurred by US aid to banks and stimulation of its economy, weakening the dollar. When its dependence on external markets decreases to a minimum, China may refuse to buy US Treasuries, felling the dollar and making the entire global economy stand still for some time, that could be enough for it to become the world’s leading economy. 

But that’s just a probability. China is still a developing country, with its GDP’s share in the global economy amounting to just 6 per cent – compared to 25 per cent of the US GDP. Time will show. 

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