To Buy or Not to Buy: China is in a Quandary

Beijing is caught in 'trap' over dollar

By Jamil Anderlini in Beijing

May 25 2009
Wall Street Journal


China's official foreign exchange manager is still buying record amounts of US government bonds, despite Beijing's increasingly vocal fear of a dollar collapse, according to officials and analysts.

In recent months, senior Chinese officials, including Premier Wen Jiabao, have repeatedly signalled their concern that US policies could lead to a collapse in the dollar and global inflation.

But Chinese and western officials in Beijing say China is caught in a "dollar trap" and has little choice but to keep pouring the bulk of its growing reserves into the US Treasury, which remains the only market big enough and liquid enough to support its huge purchases.

In March alone, China's direct holdings of US Treasury securities rose by $23.7bn (£14.9bn) to reach a new record high of $768bn, according to preliminary US data, allowing China to retain its title as the biggest creditor of the US government.

"Because of the sheer size of its reserves Safe [China's State Administration of Foreign Exchange] will immediately disrupt any other market it tries to shift into in a big way and could also collapse the value of its existing reserves if it sold too many dollars," said a western official, who spoke on condition of anonymity.

The composition of China's reserves is a state secret but dollar assets are estimated to comprise as much as 70 per cent of the $1,953bn total. China owns nearly a quarter of the US debt held by foreigners, according to US Treasury data.

The collapse of Fannie Mae and Freddie Mac, the US mortgage financiers, last summer prompted Safe to adjust its strategy and buy far more short-term US government securities, instead of longer-maturity bonds and notes.

But Safe has not fundamentally changed its strategy of allocating the bulk of its burgeoning foreign exchange reserves to US Treasury securities, a western adviser familiar with Safe thinking told the Financial Times.

He said Safe traders were "very negative" on sterling because of expectations of renewed weakness of the UK currency, but Safe was neutral on the euro and bullish on the Australian dollar.

The pound ended last week at its strongest since December, shrugging off a warning over the UK's soaring public debt from ratings agency Standard & Poor's.

The US dollar fell to its lowest level of the year against major currencies last week. Treasury yields spiked to six-month highs as investors focused on the willingness of creditors to fund a deficit that was expected to be about 13 per cent of GDP this year.

China's buying of US debt helps Washington fund its soaring deficit and there is no indication that Beijing will shy away from purchases, the Obama administration's budget chief said last week.







China