International | Feb 11 2010
By Greg Peel
The Chinese Communist Party has ordered the State Administration of Foreign Exchange (SAFE), controller of the investment of China's vast surplus of foreign exchange reserves, and state-controlled commercial banks to withdraw from risky US dollar assets and retreat to the safety of US Treasuries and agency debt (Fannie & Freddie) only.
The London Daily Telegraph's Ambrose Evans-Pritchard reports the directive was leaked to the Chinese-language Asia Times.
China is a major creditor to the US, along with Japan and Germany, so any wholesale withdrawal from US investments would have a devastating impact on the US dollar, thus wiping off billions in the value of China's foreign reserve surplus. SAFE and the state-owned banks together control about US$3 trillion of foreign holdings, it is estimated, although the breakdown of investments is a state secret.
The Telegraph notes, however, that SAFE is believed to have purchased large amounts of US corporate, state and municipal debt as diversification in the boom years of 2006-07. Were China to shift from such riskier exposures to safer Treasury and agency exposures the net US dollar impact would be square, however BNP Paribas suggests the retreat from risk itself would likely prompt more US dollar buying from elsewhere.
More onerously, withdrawing from bond positions in the debt-ridden state of California, for example, could have “serious implications”, Evans-Pritchard notes.
As to why China has decided to reduce its risk exposure in this fashion is not clear, although it is not considered to have anything to do with retribution for Taiwanese arms sales. More likely China is fearful of the risk of credit spreads widening as the US Federal Reserve winds back its quantitative easing measures and begins tightening monetary policy. A sharp jump in spreads would cause China substantial losses.
The economists at SAFE are no fools, the Telegraph suggests, given the body's chief investment officer Changhong Zhu was poached from his role of head of hedge fund derivatives trading at the world's most highly respected bond trading firm, Pimco.
It is also noted that China's surplus is on a downward path while the rest of the world deals with local deficits and economic weakness and restrains Chinese imports. The recent bounce in the US dollar is attributed also to a retreat from risk, as the dollar carry trade is unwound over fears generated by the Greek credit debt crisis.
The Telegraph reports HSBC as suggesting that the dollar's rise will not be sustained in the longer term as the same focus applied to Europe at present, and maybe the UK next, will eventually swing back again to the size of the US deficits.
