Chinese School - China's reserves: Golden dragon or sitting duck

BIZCHINA / Weekly Roundup

China's reserves: Golden dragon or sitting duck

By Edward Krowitz (China Daily)
Updated: 2007-06-07 10:22

To bring the US current account into balance, it is estimated that a
depreciation of the US dollar anywhere from 30 to 40 percent is needed in
real terms, equivalent to a loss for China of almost one year's worth of
foreign exchange earnings.

The 2007 increase in China's reserves is estimated at $320 million. One
source has called the amount held in reserves an enormous waste of
resources that is not being put to use in alternative investments with
higher returns, such as domestic spending on health care, pensions and
education.

The plausibility of the plunge scenario taking place is the continuation
in the unprecedented size of the US trade deficit, the largest in the
world.

Deficits have risen by an annual average of $100 billion over the last
four years, though moderating somewhat to 6 percent of GDP in the first
quarter of this year. This deficit is financed by surplus countries,
mainly in East Asia and the euro area, investing their dollars in US
financial assets, mainly treasury bonds.

The question that comes to mind is how much longer will foreign investors
continue this strategy before they too have a Wilie E. Coyote moment,
suddenly realizing the dollar's value doesn't make sense and unload their
holdings? At this moment, would China continue to place some $200 to $300
billion a year in an asset that might suddenly lose its value?

Some commentators, such as John Lipsky and Miranda Xafa of the IMF, take
a contrary view.

They essentially agree with Charles de Gaulle on the alleged ability of
the US to force the world to accept dollars and a low return on
dollar-denominated securities because of the dollar's key currency
status, a strong tradition of protecting private property, and its place
as a safe haven in a stormy world.

This contrarian view maintains that, by correct measurement, foreigners
don't own that much of the US economy, markets essentially have it right,
and countries will continue to underwrite the US trade deficits
indefinitely by continuing to purchase US treasury bonds.

The conclusion of this saga will be played out in international markets
over the coming months and years with no action possible on the US side
before a new administration takes office in 2009.

A large portion of Chinese savings - made possible by the sweat of its
work force expended on accumulating the trillion dollars in assets over
these years - hangs in the balance.

A sound investment strategy would caution against putting all one's eggs
in a single currency basket. Dragons, together with their legendary
golden hoards, have long since disappeared from the face of the globe,
but many sitting ducks remain, getting turned almost daily into a roasted
meal for someone else.

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