China Must Be Very Concerned About The US Dollar

The dollar’s downward spiral may not be visible to most, it certainly is there. The US dollar index has been in a wide trading range in the last 12 to 15 months, between roughly 78 and 85 points.

Today, Bloomberg reported that China, who is the largest foreign creditor of the US, reduced its US Treasury holdings in December by the most in two years. That comes after the Federal Reserve announced its plans to slow asset purchases.

The nation pared its position in U.S. government bonds by $47.8 billion, or 3.6 percent, to $1.27 trillion, the largest decline since December 2011, according to U.S. Treasury Department data released yesterday. At the same time, international investors increased holdings by 1.4 percent, or by $78 billion, in December, pushing foreign holdings to a record $5.79 trillion.

A less nuanced chart was released by Zerohedge in which it appears that the December decrease of US Treasuries by China was the second largest in history.

china_treasury_holdings_2001_2013

This evolution brings up two questions:

  1. What are the Chinese up to?
  2. Is China pushing to replace the dollar by their own currency?

Two questions which seem easy to answer on the surface. However, the answer could be more complex than most would think. That’s why the view of a currency specialist is really required. Jim Rickards, author of the book Currency Wars, explains that China’s aim is to replace the dollar by SDR’s [Special Drawing Right, a type of money for governments]. It is issued by the IMF, and China is simultaneously lobbying for more votes in the IMF. (source)

China is trying to use its willingness to lend money to the IMF to purchase SDR notes from the IMF to give the IMF money to bail out Europe. It’s trying to use that as a lever to get more votes. If it has more votes, it would be comfortable using the SDR as a reserve currency, because its use would be regulated by the membership and that would make China the second largest member after the United States.

The United States is opposing it, but Christine Lagarde, is pushing very hard to increase the Chinese role. It’s a complicated global game.

If you said to me, does China want to get rid of the dollar as the global reserve currency, the answer is yes. But most people think it’s that they want the yuan. They don’t. It’s the SDR.

Is China aiming to have their yuan become the world reserve currency? The spontaneous answer would be “yes”, but here again, Jim Rickards has a different opinion. He thinks that the yuan will not become the reserve currency for two reasons:

A: They don’t want to open their capital account. B: The yuan can’t possibly be a global reserve currency. It is expanding in use as a trade currency, but most people don’t understand the difference between a trade currency and a reserve currency. The trade currency is just a way of keeping score in the balance of payments mechanism.

Rickards distinguishes a reserve currency and a trade currency. For instance, in trading agreements between Brazil and China, it could be true that Brazil agrees to take yuan for Brazilian goods, and China agrees to take reals in exchange for Chinese goods. The countries settle up every now and then. That’s a trade currency. “But to be a reserve currency means that countries that have reserves have to invest it in something, so you need a deep liquid pool of investable assets. China does not have that. There is no Chinese bond market. There are a few Dim-Sum bonds and a few other things, but there is no Chinese government bond market to speak of, and it would take 10 to 15 years to develop one.”

But it’s not just about issuing debt. China doesn’t have to borrow because they have too many reserves. If they don’t borrow then there are no bonds, and if there are no bonds there can’t be a reserve currency because there is nothing to invest in.

Even if they did, there is no rule of law in China, so why would you trust the Chinese not to steal your money? So putting all that together, they are not even close to being a reserve currency.

Taken all this together, it seems that things are more complicated as they seem. There is no easy solution to replace the dollar would it collapse under its own debt burden. SDR’s could become an alternative. So the question is why China is buying huge amounts of gold? This is what Rickards has to say about it:

All we have to do is inflate our currency and pay them back in cheaper dollars and that reflects a wealth transfer from China to the United States. So China is completely vulnerable to that, which is why they are buying gold to create a hedge. If we inflate, then gold will go up. So what they lose on the paper, they make on the gold.

China is buying gold to hedge against the dollar’s loss of value, they are not necessarily buying gold to introduce a new gold standard and impose it as a world reserve currency. From that perspective, the Chinese must be very concerned about the dollar.

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