Last night, I woke up screaming into the night. Ugh, another nightmare about the Chinese dumping their dollars. In recent months the amounts of foreign currency reserves held by the Central Bank of China has ballooned to $2.4 trillion, with well over a trillion being made up of greenbacks. The standard argument against the Chinese dumping their dollars in favor of a currency with better long-term prospects is that to do so would destroy the value of their own holdings as they executed the trade. But what if there was a way they could do it safely?
Hundreds of billions of dollars are managed by China’s de facto sovereign wealth fund, the Chinese Investment Corporation, which in the past has made investments in stocks and a US private equity firm. Why couldn’t this organization just tap into the two trillion dollar forex markets and short the US dollar while the Central Bank of China pushes treasuries out the back door? It wouldn’t be received well politically by America, but is there any technical reason it could not be done? If Warren Buffett could use tens of billions to short the dollar in the early 2000s, surely the Chinese could do so in Hong Kong and other market centers around the world. They could short a hundred billion, liquidate a hundred billion, rinse and repeat.
Still, this would mess up their economy. A peg to the dollar would become impossible, and thus appreciate the yuan rapidly, causing devastation to their export sector, threatening internal stability. I think this may be the real reason they do not exit their dollars in any way whatsoever. Furthermore, conceptually, it might be better to think about the currency reserves as a huge liability on the balance sheet as those dollars have all been loaned out in yuan domestically.
Please comment and write to me and tell me why this would not work. I don’t say that as a challenge, I just really want to know because I think it is an interesting proposition.