Stable forex reserve serves our interest

It is reported that by the end of April 2009, China had trimmed its holdings of US treasury bonds by $4.4 billion, from $767.9 billion in March. It was the first time in over a year that China reduced its holdings of US bonds. This may indicate a significant shift in the foreign economic strategy as well as the administration of foreign exchange reserve of China.

The release of this news coincided with the first summit of BRIC (Brazil, Russia, India and China) leaders in Russia. This summit is significant for making the term "BRIC" a reality. In other words, it forms the cooperative framework of the four, most important emerging economies. There is the widespread concern in the international market that the US dollar may further lose its value. Beside China, Russia and Brazil also expressed their intention to reduce holdings of US treasury bonds.

Although the amount trimmed is rather small when compared to the $700 billion US treasury bonds that China holds, this action is of great symbolic significance - to drive home the point that China plays a vital role in the international economic system now.

Emerging economies such as China, purchase huge amounts of US treasury bonds, which is as good as giving huge loans at a low interest rates to the US for developing its domestic economy. In other words, it is the national savings of China that supports the overdrafts and consumption of the US. The relationship between the two economies will significantly change if China adjusts its strategy of purchasing US treasury bonds. The adjustment may be only a step to further improve the foreign exchange reserve policy of China, but it would be a great challenge for the economic recovery of the US.

It is high time we reviewed the current international monetary system. As the dominant currency of the Bretton Woods system, the US dollar directly influences the price of gold. Moreover, nowadays inflation and depreciation of the US dollar also impact on the circulation of commodities in the international market. The current monetary system, which is central on the US dollar, has a direct impact on emerging economies, including China.

Therefore, at this stage, it is an effective measure for China to retain its dominant position by holding huge amounts of US treasury bonds. This will serve to keep the US from randomly issuing more currency notes.

Given that any foreign exchange policy adjustment of China has great influence on the US, the reduction of US bond holdings seems like a short-term competition between the economic powers, rather than a long-term adjustment of China's exchange reserve policy.

From the view of maximizing profits, China should keep its foreign exchange reserve and investment stable and balanced. It may be necessary for China to adjust the amount of its US treasury bond holdings. However, if China trims its holdings of US bonds on a large scale, it will lead to a sharp slump in the returns on the bonds, which will eventually harm China's interest.

Furthermore, although competition is unavoidable, it is believed that win-win is the most important principle of competition between economic powers like China and the US. Admittedly, in the short term, China can hardly change the current market structure wherein "China deposits while the US consumes". Nevertheless, China cannot strengthen its position in the global market by destroying the US economy, since it will lead to a greater collapse of other economies, too. On the contrary, to adjust the structure of foreign exchange reserve and investment steadily in an orderly way is in accord with the long-term economic interest of China.

Some radicals suggest that China should massively reduce its holdings of US treasury bonds and switch to increased holdings of gold. Although somewhat reasonable, it is actually impracticable since it goes too far. Whether it is gold or any other instrument of investment, they all pose the same dilemma: Whatever China purchases, there will be a rise in the price of that item. This is a major obstacle to China's foreign exchange reserve adjustment.

In a word, it is better to treat the foreign exchange policy of China as a bargaining counter for the competing interests of the economic powers rather than focus solely on the profits of foreign exchange investment.

The author is an anchor with China Business Network TV in Shanghai.

(China Daily 06/18/2009 page8)