Why China Won't Dump USD Reserves

 |  Includes: DBV, FXE
by: Raj Dhamodharan

There are a couple of reasons why China may not dump their significant investments in US treasuries in a hurry.

First - and this may sound strange - a comment from a senior Chinese official indicated that China may need to take advantage of the stronger currencies (read Euro) to achieve better returns for their huge foriegn exchange reserves. These comments led currency markets to dump dollars and move to Euro. Euro now is at all time high against the dollar. If China really wanted to do this, why would a senior national official speak out so publicly against an investment in which they hold large numbers? The comments have decreased the value of their holdings significantly and increased the price of their future investments (Euro).

Secondly, most of Chinese export revenue comes from the US (something like $200 billion out of $270 billion total exports goes to US). These exports are the primary driver of economic growth in China. As I have noted before, Chinese investment in US treasuries indirectly help fund the consumer spending in US which in turn results in more imports from China. China would not want to jeopardize this circle of dependency on a short order.

China would certainly want to diversify their holdings and they have shown that in the past. Over time they may move out of USD positions but they are likely to do so in a slow and methodical manner.

However, other countries with export powered economies and huge foreign reserves may feel the need to get out of USD sooner than the rest. Unless they coordinate among themselves and agree to the common approach proposed before, we will see more turbulence in the currency markets in the coming months.