Farrell: Why China Won't Quit The Dollar

China and the dollar- part two

China increased its Treasury holdings by 40% in 2008 and bought more in January of 2009. If China wanted to substitute another currency or a basket of currencies for its dollar holdings, they have been free to do so. And to some extent they have, as the dollar has fallen from 70% or so of the world's reserve assets to 63-64% or so today.

Even with that, the Chinese have chosen to increase their US holdings.

There is no country—or group of countries—ready to take the place of the US. We recently have coined the phrase "The Pigs," referring to Portugal, Ireland, Italy, Greece, and Spain: All euro zone members and all in some degree of difficulty which, of course, weighs on the euro.

The euro zone was assisted in its travails recently by the dollar being made available by Bernanke in unlimited quantities. The euro needed the dollar to get itself stabilized. The euro won't be used as a substitute for the dollar but as an adjunct to the dollar.

The Brits failed to capture sufficient bids for an offering of bonds Wednesday, and while the yen is big and liquid, that's not new news and has been available for trade/investment to the Chinese (although they have been traditional and ferocious enemies).

SDR's—Special Drawing Rights—are an "artificial" currency used internationally to settle trade balances and are sponsored by the International Monetary Fund (I said the World Bank in an earlier note: wrong again!). They were created in 1969, but I wager that most reading this memo have never heard of them. Their use has not grown with the globalization of world trade, so to think they could be vaulted to international status versus the dollar is naïve. Since the US has about 17% of the votes at the IMF and China less than 4%, the noise by China could be a move to flex some muscle and get some more juice at the IMF as a peace offering.

China has no bond market to speak of, so there would be no ability to use the Chinese currency as a reserve haven even if you wanted to. There is nothing to buy.

This circus created by the Chinese could be moved to the floor of the US House of Representatives, home to unconstitutional and idiotic legislation. It would have a natural home there.