Saturday, November 11, 2006

American Mid terms - Chinese Reaction

While most of the planet was overjoyed at the Dem gains in the American mid-terms, it turns out one country was not - China.

According to Bloomberg, on Thursday Zhou Xiaochuan, chairman of the People's Bank of China, told the press that China intended to continue diversifying it's foreign reserves. Just in case people didn't the message, he repeated it on Friday in Frankfurt, saying

they would ``stick to the existing policy'' of reducing the share of U.S. assets it holds, because of ``safety, efficiency and liquidity.'' When asked whether China is selling dollars, he said: ``No.''

This means putting new money directly into non-dollar currencies (while keeping the existing reserve where it is), and China has been doing this since about 2003 - so why the song and dance now, especially just as their dollar reserves (held mostly in US Treasuries) hit the $1 trillion level?

It's because they are nervous of the Dem control of Congress and wish to fire a shot across their bows. Charles Schumer a Democrat Senator, has been sabre rattling about China's trade surplus and "under-valued" currency for a while. In 2005, he and Senator Graham (Republican) tabled a bill that proposed to slap a 27.5% tariff on Chinese goods if they didn't revalue the yuan within two years. The Chinese responded by revaluing the yuan by 2.1% in July 2005, and easing the peg to the dollar - the yuan now moves against a basket of currencies (the make-up of the basket is unknown). After a trip to China in March 2006, Schumer and Graham shelved the bill for a further six months to give the Chinese more time - and the yuan has been slowly strengthening against the dollar since.

It's not known if Schumer and Graham are serious about their bill, or whether it is just a useful tool to pressure the Chinese. Tariffs and protectionism would be a bad thing, and would hurt America as well as China. The Dems tend to be associated with protectionism (notwithstanding Clinton's NAFTA and other ground-breaking trade deals). The Chinese are clearly worried, as the Dems now have enough votes to pass their bill and they've decided to do some sabre-rattling of their own. On the other hand, the Bush administration was clearly negligent in letting it's spending get so large that they had to borrow from the Chinese to the tune of a trillion. No one should be that dependant on a foreign lender.

Hopefully the Dems will exercise caution and not take punitive measures against the Chinese. And hopefully they will cap US spending and bring the deficit back (which should solve the whole issue of having to borrow abroad so much).

Speaking of nervous countries, an American blogger le-enfant-terrible, had this to say about Syria's foreign currency manoeuvres;

Throughout the year Syria has been transitioning from the dollar to the Euro. In February it switched its international transactions to Euros and by July it had switched over half of its central bank's currency reserves. Other articles indicated that before the end of the year Syria would stop pegging its currency to the dollar (in favor of some basket of currencies).

The Syrians are clearly worried that any dollar reserves parked in Treasuries would be in danger of being frozen by the US at George Bush's whim, and are taking steps to protect their money. I wonder how many other countries are doing the same.


Anonymous said...

a) chinese are serious folks and play the long game.
b) people say one thing when NOT in power and do another when they are in. perceptions of the reality of life changes.

Anonymous said...

interesting below-the-radar commentary on Syria there, snowflake.

Aaron Murin-Heath said...

If the Chinese pull the plug on the dollar, the US economy will collapse into reccession.

Yuan = cheap dollars = low interest rates = boyant housing market and cheap secured credit = boyant US consumer climate and growing retail, service and financial sector in US, which is growing the overall economy.

mephi said...

Given how jittery the currency markets have been lately I'm surprised that more people here in the US aren't talking about the dollar. The last time it was a big issue was about a year and a half ago when it was hitting some major lows amidst huge concern about global trade/flows imbalances. The amazing thing right now is that the dollar is having new problems just as the global flows are starting to move towards balance again. Given that the dollar is about where it was a year and a half ago I'd say that it will soon become a big issue here again.