Tuesday, January 10, 2006

Heading for the exits

China Set To Reduce Exposure To Dollar

China has resolved to shift some of its foreign exchange reserves -- now in excess of $800 billion -- away from the U.S. dollar and into other world currencies in a move likely to push down the value of the greenback, a high-level state economist who advises the nation's economic policymakers said in an interview Monday.

As China's manufacturing industries flood the world with cheap goods, the Chinese central bank has invested roughly three-fourths of its growing foreign currency reserves in U.S. Treasury bills and other dollar-denominated assets. The new policy reflects China's fears that too much of its savings is tied up in the dollar, a currency widely expected to drop in value as the U.S. trade and fiscal deficits climb.

China now boasts the world's second-largest cache of foreign exchange -- behind only Japan -- and is on pace to see its reserves climb past $1 trillion later this year. Even a slight diminishing of the dollar as a percentage of those holdings could exert significant pressure on the U.S. currency, many economists assert.

In recent years, the value of the dollar has been buoyed by major purchases of U.S. Treasury bills by Japan, China and oil-exporting countries -- a flow of capital that has kept interests rates relatively low in the United States and allowed Americans to keep spending even as debts mount. Some economists have long warned that if foreigners lose their appetite for American debt, the dollar would fall, interest rates would rise and the housing boom could burst, sending real estate prices lower.

I saw this reported a few days ago, but never got around to blogging it.

There is a sense in which China and the U.S. are scorpions in a jar -- a huge percentage of China's GDP heads to the big PX, but we in effect have been buying it with a credit card issued by the merchant -- that is, by China. By moving their reserves into Euros and Yen, China is sending a strong "no confidence" message in their biggest customer. They know full well that dumping dollars could have the effect of tanking our economy, which will ripple back to hurt their own economy. So they must be pretty convinced that the end is near to be willing to endanger the open bar that has kept the party going for so long.


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