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China and the Dollar
Posted by: Jon Henke on Friday, January 06, 2006

Via Econopundit, I see the Chinese may be looking at diversification...
China indicated on Thursday it could begin to diversify its rapidly growing foreign exchange reserves away from the US dollar and government bonds – a potential shift with significant implications for global financial and commodity markets.
If so, let's hope it's a gradual diversification, rather than a sudden divestment. The markets can adjust to a slow leak; a quick pop might turn the disequilibrium into an immediate crisis.

I've been wondering whether the Chinese strategy might not be to create an US dollar bubble, so that they can engineer a sudden US economic crisis at a time strategically useful to China. At the same time, China has been extending their own economic tentacles around the world, ensuring that — should the US suddenly lose prestige and economic leverage — "gap" nations have a fall-back partner.

The problem with this strategy would be that any US economic crisis would do a great deal of economic damage to China. Perhaps that's a risk they're willing to take. I can't tell.
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Previous Comments to this Post 

Jon, I certainly can’t disagree with your thoughts on this issue as they mirror my own. China, over the past year especially, seems to be doing whatever it takes to put themselves into a position to slowly devalue the dollar (something that the Federal Reserve with their ever increasing M3 totals seem to be ignoring).

However, I do take a small issue with your point that any US economic crisis would do a great deal of economic damage to China. In the short term, I agree ... but in the long term, given their deals with Russia, the EU, and Iran I don’t see a major crisis hurting them; much the opposite, in fact.

A major US economic crisis would, in the short term, create a lower demand of goods ... but given the long term, it would eventually lead to more consumerization of goods produced in China due to their relatively lower cost than those produced elsewhere (i.e. Wal-Mart will still be booming).

I’d like to hear your thoughts.

Written By: Abject_Disappointment
I think the American position is very much stronger than you fear. Consider the old saying: "If you owe the bank $1 million, you have a problem; if you owe $100 million, the bank has a problem."

China’s strong-currency policy impoverishes the Chinese on average, but it creates more jobs (though each is lower-paying in dollar terms). That is, it spreads prosperity as widely as possible, at the cost of it being thinner than the most successful would like. The Chinese government is structurally bound to this policy, as it is their best tool for preventing widespread unrest.

In the markets, the USD yield curve continues to invert (i.e., rates are low at the long end) — not the action of a trading community that expects China to soon be dumping long-dated U.S. debt.

[Cross-posted at Stone City.]
Written By: sammler
I must be missing a piece of the puzzle that you guys see. I see the market setting the value of the dollar, not China.

If China flooded the market with US treasuries, the market price of the treasuries would drop precipitously and China amasses stockpiles of other commodities used to pay for the now reduced-priced treasuries (the market price only drops if there are buyers). As the dollar falls in relation to all other commodities, those commodities would also flow into the US as dollar-denominated goods and securities are now cheaper. That flow would put upward pressure on the dollar.

As soon as China stops selling US treasuries, the upward pressure on the dollar would return its valuation to neutral, meaning the devaluation is momentary. At the end of the day, whoever purchased the reduced-priced treasuries would be richer to the extent that China and panic sellers are poorer. The US is at worst unaffected by the momentary devaluation, at best far richer in relation to China as individual investors (and the US government) would certainly be counted among the purchasers of the treasuries.

The length of the "US economic crisis" is limited by the amount of hurt China can stand (hours or maybe even days). Since China has such a large positin in US treasuries, though, any selling program they commence would be designed to (at least momentarily) appreciate the value of a dollar to maximize their return on investment.

Long-term, while it may be in China’s best interest to spread their reserves to other commodities, the only way they can block their reserves being at least linked to investments in the US is to block exports from China to the US including blocking resale of their goods to the US by their other trading partners. Interestingly, this would result in massive investment by US investors in China (unless they sever all trade ties).
Written By: Brock
URL: http://
Brock’s comment is interesting, but the thing he’s missing about China is that their currency is not sold on the open market, but fixed to the USD at a floating rate of 8.03 to 8.20, limits set by their central bank. So from the start, there is an interference in the normal exchange of currency flows. It’s not known if they would be able to adapt to market fluctuations if there was a massive change- like what would happen if they sold their USD reserves. Would something else be there to buoy them, like their central bank? Most unlikely, despite many of their improvements and developments.

A vigorous discussion is also underway at Samizdata (, over China’s role in the upcoming future of the world economy.

Let the buyer beware, let’s see what happens if a major recession hits- who will be structurally able to manage themselves economically and politically? Don’t fall into that psychological state where you get lost in the possibility and lose touch with reality- as any study of China’s interaction with Western/European powers going back to good ’ol Marco Polo will see. The Brits, 150 years ago mind you, were talking about how wonderful it would be to have market access to the Chinese consumer- the very same crap the China people here would have you believe today! Never panned out for them. How much of a hope do we have for full WTO compliance by 2007? Fat chance.

Written By: Sunguh
If anyone would like to open a Chinese yuan account, Everbank, an on-line American bank offers them. no interest and a minimum of US$ 50,000 gets you in.
Written By: Harun
URL: http://

US companies are doing well in China, especially with weaker brands.

I was there over the holidays and enjoyed Pabst Blue Ribbon and saw a lot of people driving Buicks. McDonald’s was very busy.

Meanwhile, Tsingtao is now owned by Foster’ even the Chinese brands make foreigner’s money.

But yeah, full WTO would be better.
Written By: Harun
URL: http://
I have always felt that we in the West see the Chinese dollar reserve size in capitalist terms while China is ruled by a fairly determined Communist Party. In their eyes the US is hardly an old friend—think communist revolution, North Korea, North Vietnam, American airbases and aircraft carriers encircling China, etc. How can China hope to defend itself from our military might? Certainly not by playing the game by our rules.

With the thirst for oil at issue between our countries and both having to look overseas China feels threatened by our sea power. How can China fight back if we take military action? It can enter a "sell" order of its dollar reserves which will be an economic earth quake and force other major dollar reserve holders to try to sell as well.

Sure it will cripple the Chinese economy for a while, but China has survived in a hostile world before. For the US economy it would likely destroy the dollar as the world’s reserve currency as well as our ability to finance our international deficit with more treasury notes.

I see the huge Chinese dollar reserve as the Chinese defense budget held in readiness if the White House and Pentagon attack North Korea, encourage Taiwan independence, block the Malacca Strait or engage in other military intrusion.

Sinned in Dallas
Written By: Sinned
URL: http://

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