China: Dollar is Heart of FX Reserves Despite Worries

The dollar stands secure as the anchor of China's mammoth foreign exchange reserves, even as Beijing seeks to diversify its investments across different currencies and assets, the forex reserve regulator said on Friday.

The statement by the State Administration of Foreign Exchange, which manages the country's $2.3 trillion of currency reserves, followed a suggestion earlier in the day by an official from the agency that diversification has been very gradual.

Wang Xiaoyi, deputy head of SAFE, said China had maintained a consistent reserve allocation in different currencies and that dollar weakness was a long-term trend, not a near-term worry.

China's desire to see a stronger dollar was reinforced by an opinion piece in the People's Daily, the main newspaper of the ruling Communist Party, which said that the slumping greenback was harming the world economy.

Global markets have periodically been shaken by the idea that China could dump dollars, as it is estimated to hold about two-thirds of its currency reserves in dollar-denominated assets.

Beijing itself has long declared that it aims to diversify its forex reserves, the world's biggest such stockpile.

"A properly diversified currency structure in FX reserves, with the U.S. dollar as the main part, can satisfy external payment and asset allocation needs fairly well," SAFE said in a publication explaining how it manages the reserves.

In practice, this has meant that China has continued to focus its investments on dollar-denominated assets, even while branching out into euros, yen, sterling and more.

"We now have similar proportions of different currencies in our forex reserves as we had before," Wang said on the sidelines of a conference in Beijing. "The weakening of U.S. dollar will be a long-term trend but we don't see big fluctuations in the near term," he added.

Despite expressions of concern about the yawning U.S. debt, China has continued accumulating dollars this year as it must buy those streaming into the country through its trade surplus to keep the yuan from appreciating.

"We are not making any big adjustment in how to manage our foreign exchange reserves, and all our operations are in line with our existing forex management goal," Wang said.

Policy Frustrations

The weak dollar has complicated monetary policy in China, as in other countries that fix their exchange rates to the dollar.

Raising interest rates would widen their rate differential compared with the United States, potentially attracting speculative capital. But keeping rates flat is arguably too loose for economies that have recovered as strongly as China's.

The People's Daily vented these frustrations on Friday.

The sluggish dollar was "holding back" other countries' economic recovery, forcing them to choose between squeezed exports and inflation risks, Zeng Gang, an economist at the Chinese Academy of Social Sciences, said in a commentary.

"The sustained weakness of the dollar is to a considerable extent holding back the economic recovery and policy adjustments of other countries," said the commentary.

If other countries "allow their currencies to freely appreciate, then their already severely diminished exports will deteriorate," it said.

"If they maintain exchange rate stability (against the dollar), their central banks will have to buy more dollars on the foreign exchange market, and this will increase liquidity in their own currencies, further inflating asset prices," it said.

The comments echoed those last month by Chinese banking regulator Liu Mingkang, who said that ultra-low U.S. interest rates and weak dollar were a "new systemic risk" for the global economy, driving up asset prices in emerging markets.

China's Responsibility

Such criticism was dismissed by U.S. Federal Reserve Chairman Ben Bernanke on Thursday.

Answering questions at a confirmation hearing, he said countries that are concerned about speculation "have their own tools to address bubbles in their economy" and shouldn't look to U.S. monetary authorities to do the job for them.

Zeng, writing in the People's Daily, said that "swift policy actions" were required to minimize the dangers posed by a weak dollar.

But "traditional methods" such as interest rate and exchange rate adjustments were of little use in this effort, and regulators must instead strengthen supervision of markets, he said.

In a similar vein, a government economist argued in a separate commentary that China should use targeted policies to prevent a property market bubble from inflating.

China should enact a property tax "at a suitable time" and assess additional taxes on second and third homes to limit speculation, Ding Yifan, a researcher at the Development Research Center under the cabinet, wrote in the China Daily.