IMPORTANCE OF CHINESE DOLLAR RESERVES

China imports resources for its growth from many countries and exports manufactured
goods. Currently, however, this process is not balanced. The Chinese export more than
they import, and therefore accumulate a great deal of cash. China also possesses over
$1 trillion of reserve currencies, and how it uses and invests this reserve of U.S. dollars
will have a major impact on the direction of the U.S. dollar. The Chinese State Administration
of Foreign Exchange (SAFE) is the key agency on the future of these dollar
reserves. For the forex trader, following Chinese developments and intentions on global
trade and currency policies can be rewarding because it can point the way for new trading
opportunities. One big effect could result from a possible slowdown in the China
economy. The U.S.-China Economic and Security Review Commission concluded that:
A financial crisis in China would harm its economy, decrease China’s purchase
of U.S. exports, and reduce China’s ability to fund U.S. borrowing, particularly to cover the U.S. budget deficit. An economic crisis in China has the potential to raise
the U.S. interest rates, thereby placing major additional costs on U.S. businesses
and individual consumers and producing dislocation in the U.S. economy. It could
also exacerbate Chinese domestic political tensions in an unpredictable fashion.
This is why the condition of China’s financial system is of concern to the United
States. (October 30, 2006)
If a possible slowdown in China worries U.S. traders, possible changes in China’s
investment in U.S. assets worries them even more. The influence of China was most
recently demonstrated when during the 2006 Thanksgiving holiday, a statement by the
Chinese minister alluding to China’s potential for investing in nondollar assets started a
major slide in the U.S. dollar around the world. Here is an excerpt from recent Congressional
testimony:
The United States will run a current account deficit of over $800 billion, or approximately
7 percent of the GDP, in 2006. This is historically an extremely high
level that no other country has been able to sustain for any significant period. The
danger is that the U.S. economy could suffer a precipitous decline if the ability
of the United States to borrow ever-greater amounts should end abruptly. Interest
rates and inflation might suddenly soar as the dollar fell and the stock market
crashed. (“China’s Exchange Rate and the Effect on the U.S. Economy,” Committee
on Financial Services, October 1, 2003)

Other currencies do not escape the impact of Chinese economic developments. Since
the Chinese growth rate of over 10 percent per year GDP generates a voracious appetite
for resources such as oil, copper, steel, iron ore, cement, and Ag complex, the countries
that provide these resources experience a demand for their dollars. When China buys
copper from Australia, renminbi must be converted into Australian dollars. This provides
support for the Australian dollar and the Australian economy. Since China imports major
resources such as copper from Australia, the aussie would be affected by a potential
Chinese slowdown. Also, Japan, a significant trading partner of China, and its currency
will often weaken or strengthen on expectations of a Chinese slowdown or sustained
growth.
Chinese influence has begun to extend also to Africa. For example, Chinese exports
are beginning to shift to the Suez Canal, rather than going around Africa. This is causing
Turkey, Italy, and other nations to invest in Egypt to tap into Chinese export to Europe.
In the coming years, the trading world will focus on whether China can control its
growth rate, avoid inflation, and increase its currency float. Therefore, China’s economic
and monetary policy will be valuable to watch. Traders need to keep track of key performance
parameters such as Chinese GDP and inflation projections, as well as Chinese
interest rate decisions. Between 2006 and July 2007, China increased its interest rates
to reach a level of 6.84 percent for one-year notes to try to slow down the economy.
Whether this will work is unknown. But as China, which is now the seventh largest economy
in the world and the second largest in purchasing power parity, becomes more of a
consumer economy, the status of the Chinese economy will become easier to monitor.
Companies such as Home Depot, Wal-Mart, Kingfisher (British), and Best Buy are entering
the Chinese market, and many other firms are acquiring Chinese companies. As a
result, the coming years will provide more reliable data on Chinese consumer spending
and growth.
Watching China’s currency policies can also pinpoint new trading opportunities in
the China market. The Shanghai Composite Index is very sensitive to whether the renminbi
will strengthen. When the Bank of China’s governor, Zhou Xiachuan, commented
that China wasn’t interested in increasing its foreign reserves further, the Shanghai index
soared because Chinese company land and property is denominated in Chinese currency.
Their value would increase (Wall Street Journal, March 22, 2007, p. C8).
To monitor activities in China on an ongoing basis, I recommend the following web
sites:
http://research.stlouisfed.org/publications/review/06/11/Poole
www.chinadaily.com
http://english.people.com.cn/
http://en.ce.cn/main/index.shtml


By ABE COFNAS