China and The Dollar

There is a great deal of talk about China as the US creditor and how they have bankrolled the Government's spending for some time now. Just the other day China scaled back its purchase of US assets in an attempt to diversify its holdings. This week The Economist took a look at the whole picture of China and the dollar:

CHINA is America’s largest creditor. Thanks to a policy of piling up foreign-exchange reserves and investing most of them in dollar assets, China’s government bought around one quarter of the net increase in Treasuries over the past two years. But just as Washington needs to sell record amounts of debt to fund its soaring budget deficit and to bail out its banks, there are signs that Beijing’s appetite for American debt may be shrinking.

According to official figures, China’s reserves fell in January and February. Taking the first quarter as a whole they rose by just $8 billion, compared with $154 billion a year earlier.

So we have an apparent scale back, but how much do they currently have?

According to the official figures, China’s foreign reserves are $1.95 trillion. But Mr Setser (Council on Foreign Relations) reckons that the true figure is around $2.3 trillion if hidden reserves are included, such as those of the China Investment Corporation (CIC), the country’s sovereign-wealth fund, and the “other foreign assets” of the PBOC. Taking this wider measure of foreign-exchange reserves, and then adjusting for changes in the value of non-dollar reserves caused by swings in the dollar, Mr Setser reckons that China’s total reserves rose by around $40 billion in the first quarter, only one-fifth of their increase in the first quarter of 2008. On the face of it, this represents a big drop in China’s demand for foreign assets.

2.3 trillion, wow that is almost one year of Obama spending! So what are they holding:

What of the idea that China’s government has diversified into other currencies? Here, too, the statistics are hard to make sense of. The State Administration of Foreign Exchange (SAFE), which manages the country’s reserves, does not disclose such details. America’s Treasury reports on foreigners’ investments in American securities, but these figures may understate China’s stash because China buys some dollar assets though non-American intermediaries. For instance Mr Setser and his colleague, Arpana Pandy, estimate that since mid-2006, China has accounted for around 30% of purchases of American Treasuries though London. If these flows are added in to Washington’s figures, China has about $1.5 trillion invested in dollar assets, of which about half are in Treasuries. This is about 70% of China’s total reserves. While that is down from over 80% in 2002, the drop largely reflects the weaker dollar, not a shift into other currencies.

The article points out that not all of the US assets bought by China are actually through the government. In many cases "private" hands in are buying assets for their own profit. Reading the article I wish they would expand on that subject. The hybrid nature of Chinese Capitalism makes me wonder how private some of that money actually is.


Conclusion:

What does this all add up to? China is trying to have it both ways. It wants to lessen its dollar exposure, but it also wants to hold down the yuan. The picture has been temporarily clouded by shifts in “hot capital” flows, but so long as China runs a large current-account surplus, its reserves will rise. In order to keep the yuan weak against the dollar, a large chunk of those reserves will end up in greenbacks. Beijing’s appetite may not match Washington’s growing need for cash. But China cannot sour on the dollar without letting its own currency rise.