China hints at reduction in dollar holdings

By Steven C. Johnson
Reuters
Tuesday, March 24, 2009

http://www.reuters.com/article/marketsNews/idUSN2461991920090324

NEW YORK -- A Chinese proposal to ditch the U.S. dollar for a global basket-based reserve currency suggests China plans a gradual reduction in future dollar accumulation but will not dump its existing stash of U.S. assets, strategists from the Bank of New York-Mellon said on Tuesday.

China's central bank governor on Monday detailed a plan for the world to use the International Monetary Fund's Special Drawing Right, a currency basket comprising dollars, euros, sterling and yen, as a super-sovereign reserve currency.

That came shortly after Chinese Premier Wen Jiabao urged the United States to maintain its creditworthiness and ensure the security of China's massive stash of U.S. Treasury assets.

"China always says exactly what it means, and this was a very direct message to the U.S. that the appropriate level of dollar holdings in China's currency reserves should be lower," said Simon Derrick, head of Bank of New York-Mellon's currency strategy team, at a press briefing on currency market outlook.

Rather than suggesting a shift to the IMF's SDR, China may instead be signaling that it wants the dollar share of reserves to decline to about 44 percent, matching the currency's share in the SDR basket, Derrick said.

The euro comprises 34 percent of the SDR basket, created in 1969, while sterling and the yen each account for 11 percent.

Most analysts think the dollar now comprises at least 65 percent of China's nearly $2 trillion reserves. According to the IMF, that's roughly the dollar's share of reserves in countries that, unlike China, reveal the currency allocation.

China is the largest holder of U.S. Treasury debt, making it the top U.S. creditor, and Derrick said it worries that huge U.S. fiscal spending aimed at lifting the economy out of crisis will cheapen the dollar and undermine the value of its assets.

Prime Minister Wen, speaking earlier this month during the annual session of parliament in Beijing, said "we have lent a massive amount of capital to the United States, and of course we are concerned about the security of our assets."

What China won't do, Derrick said, is start dumping the Treasury debt it already holds, as that would undermine the value of its existing reserves and cause a rapid spike in the value of the yuan, undermining the economy.

"China almost certainly won't tamper with its existing reserves, as they would be shooting themselves in the foot," he said.

But reduced Treasury purchases by China and other countries will eventually put pressure on the dollar, he said, because the United States' will have to rely more heavily on printing money to finance massive stimulus spending.

The Federal Reserve said Tuesday it will begin doing just that on Wednesday when it starts buying Treasury debt.

Michael Woolfolk, a senior currency strategist at the Bank of New York-Mellon, said that means the Obama administration must assert repeatedly its belief in a strong U.S. dollar.

"They have to emphasize that, because that is the way to encourage investment and keep inflation low," he said.

The Bank of New York-Mellon has more than $20 trillion in assets under custody.

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