Chen Jiaxing: China must diversify forex, cleverly

China to Trim U.S. Treasury Holdings, Diversify Forex Reserves

By Chen Jiaxing
People's Daily, Beijing
Thursday, August 20, 2009

http://english.people.com.cn/90001/90780/91421/6734461_txt.html

China sold $25.1 billion of U.S. treasury bills in June to bring its holdings to $776.4 billion, according to data released by the U.S. treasury Department Monday. This has gratified people in China, whereas the United States keeps a close eye on the move.

Judging from the perspective of its people, however, China is in urgent need of altering the structural imbalance of its foreign exchange reserves, so that the value of reserve assets could be preserved and increased.

U.S. treasury bonds seem to have good safety and liquidity with a higher interest rate than same-term bank deposits, and they are exempt from interest tax. But the devaluating trend of the dollar will result in an intangible devaluation of treasury bonds. In such circumstances, China's first large-scale reduction of U.S. treasury debt is, beyond doubt, within the bounds of reason.

The reduction of US treasury bonds also shows that China is seeking to diversity its Forex reserves. Such diversification nevertheless poses a complex topic. The main problem China has been facing has two aspects:

One aspect is to make a scientific assessment of Forex structure so as to maximize return and minimize risk. The other aspect is to train competent personnel in the rules of the international game so they have managerial experience.

Behind the reserve diversification there is a diversification choice on excess value. First, China has to retain a certain proportion of dollar reserves, since the nation should have the basic means to ensure emergency international payments. Second, China must have a certain amount of gold reserves, a strategic national asset, to serve as a strong prop or backing at critical moments, and, third, China must keep a certain proportion of other stable currencies, such as the euro, British pound, and Swiss franc, to offer a useful hedge against dollar devaluation.

Since Forex reserves are not money of fiscal resource, they should be used mainly in external investment and international trade, or to purchase large-scale machinery and electrical equipment and sophisticated technologies and to make strategic asset investment or to join investment holding companies, focusing on high-growth investment opportunities where potential returns will exceed the cost of capital. Such an endeavor, however, has already been foiled repeatedly due to trade barriers and "firewalls" put up by a few Western countries.

The reserves also should be used to grant loans to other countries or uying real estate and housing and purchasing large-scale commodities.

The issue on the table now is to acquire a correct appraisal of diversified channels for foreign exchange reserves and define the Forex mix in a scientific way. To diversify foreign exchange reserves and define their scientific, rational structure is what China has to accomplish, and some new areas for investment need to be explored.

China has no choice but to shrink its U.S. treasury holdings. But China is still unfamiliar with the rules of the international game, and the nation is only a pupil with regard to the performance of capital. People in China could be entirely unaware of "manipulation" by banking tycoons or financiers. So China is in an urgent need of ace professionals in the banking sector good at strategic investment and management.

Forex reserves belong to the national wealth and it is natural and inevitable that the public pays great heed to their safety. Therefore, while answering some suspicions to win the public's trust, confidence, and understanding, the relevant departments should also consider how to conceal their strategic intentions to the maximum.

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