By Bloomberg News
July 16 (Bloomberg) -- China’s foreign-exchange reserves are surging again, helping the Obama administration sell unprecedented amounts of debt as it seeks to drag the world’s biggest economy out of a recession.
Stockpiles of currency rose by a record $178 billion in the second quarter to top $2 trillion for the first time, the People’s Bank of China said yesterday. The amount is close to two-thirds the size of China’s economy and the equivalent of Italy’s gross domestic product in 2006.
The cash holdings are growing as the central bank sells its currency, the yuan, to prevent an appreciation that would make the country’s exports more expensive. The yuan sales mean for all the calls by China and other emerging markets for an alternative to the dollar as the world’s reserve currency, it has little choice but to keep buying U.S. government assets.
“People are talking about whether the Chinese may actually one day dump the dollar and Treasuries because of the problem in the U.S., but they are missing the point,” said Stephen Jen, head of macroeconomics and currencies in London at BlueGold Capital LLP, which manages $1.1 billion. “The reserves are so big because China needs to keep the exchange rate stable for its exports. Therefore, they have to keep buying dollar assets.”
The need to temper gains in its currency led China, the biggest overseas holder of Treasuries, to more than double its holdings of U.S. government notes and bonds in three years to $763.5 billion in April, according to U.S. Treasury data. The amount was equivalent to 38 percent of its reserves at the time.
Stimulus Spending
President Barack Obama’s administration is seeking to sell a record amount of debt to pay for measures to revive the U.S. economy. New York-based Goldman Sachs Group Inc. estimates that government borrowing may total $3.25 trillion in the year ending Sept. 30, almost four times the $892 billion in 2008, to finance the budget deficit.
“China’s reserves will allow the U.S. to run a higher fiscal deficit than other nations,” said Bilal Hafeez, the London-based global head of currency strategy at Deutsche Bank AG, the world’s biggest foreign-exchange trader. “Their rhetoric suggests they do want to diversify their reserves but the data suggests they are doing it in a measured way. There is no dumping dollars.”
The reluctance to let the yuan appreciate when the world is mired in the deepest recession in six decades means that China will keep accumulating U.S. debt, even if the amount of its purchases declines, according to economists at RGE Monitor, a New York-based research firm headed by economist Nouriel Roubini.
“Despite China’s concerns about the value of its large stock of U.S. assets, reserve diversification will continue to be difficult,” the RGE economists wrote in a report yesterday.
Cash Surge
China’s reserves have increased by almost 14 times this decade as exports generated a trade surplus that pumped in cash. Capital Economics Ltd., a London-based consultancy, estimates that exports will account for 30 percent of China’s gross domestic product this year.
Win Thin, a currency strategist at Brown Brothers Harriman & Co., said investors have also recently pushed cash into emerging markets such as China, amid signs that their economies will recover more quickly than those of developed nations. China’s growth rebounded to 7.9 percent in the second quarter, from 6.1 percent in the first, the government said today.
Such investment inflows mean that “policy makers bought dollars and sold local currency in order to prevent currency appreciation,” Thin said in a report yesterday. He predicted that China will continue intervening to keep the yuan trading at about 6.83 per dollar through the end of this year.
Yuan’s Stability
The yuan’s value has barely changed in the past year, following a 21 percent appreciation in the three years after China scrapped its dollar peg in July 2005. The demand for dollars conflicts with China’s calls for the world to consider drawing away from the greenback as its sole reserve currency.
“As the Chinese were becoming more vocal in regard to the need to move away from the U.S. dollar, they were in actual fact buying more dollars than ever,” said Derek Halpenny, European head of global currency research at Bank of Tokyo-Mitsubishi UFJ Ltd.
People’s Bank of China Governor Zhou Xiaochuan urged the International Monetary Fund in March to move toward creating a “super-sovereign reserve currency” to replace the dollar. Premier Wen Jiabao said the same month that he was “worried” the dollar would weaken.
Speaking to Al-Arabiya television yesterday, U.S. Treasury Secretary Timothy Geithner expressed confidence that the dollar “will remain the principal reserve currency.” The dollar rose 0.2 percent to $1.4083 per euro at 3:11 p.m. and has declined less than 1 percent this year.
Dollar Dominance
The dollar’s share of global reserves increased to 65 percent in the first three months of this year, the most since 2007, according to the International Monetary Fund.
China is trying to reduce its reliance on the U.S. currency in other ways. It signed 650 billion yuan ($95 billion) of currency swaps since December with nations from Argentina to Belarus and is encouraging trading partners to use the yuan to settle cross-border trade.
The government is considering purchasing $50 billion of the IMF’s bonds after the Group of 20 leaders on April 2 gave the international lender approval to boost its war chest by $500 billion.
Investment Flops
China can afford that and more because its reserves will increase by more than $200 billion annually in coming years, said Wang Tao, an economist with UBS AG in Beijing. Increasing its strategic oil reserve to 90 days of imports, the nation’s target for 2020, would take another $50 billion, Wang added.
China Investment Corp., the nation’s $200 billion sovereign wealth fund, lost money on its first investments. It bought a $3 billion stake in Blackstone Group LP stake in May 2007 at a 4.5 percent discount to the initial public offering price of $31. The stock now trades at $9.97. It agreed to purchase $5 billion of Morgan Stanley stock with the lowest possible price at $48.07 in December 2007. Those shares trade at $28.80.
The country’s top currency regulator this week relaxed curbs on overseas investment by local businesses, allowing more funds to flow abroad starting Aug. 1.
All those measures are unlikely to reduce reserves or curb China’s need to purchase U.S. debt, said Zhu Baoliang, chief economist of the State Information Center, an affiliate of the National Development and Reform Commission, China’s top economic planning agency.
“The reserves will continue to pile up,” said Zhu. “Over the short term, there isn’t much China can do but continue to buy Treasuries while hoping the U.S. economy can recover as soon as possible so that the investment won’t suffer too much loss.”
--Kevin Hamlin, Li Yanping, Anchalee Worrachate, Simon Kennedy, Sandy Hendry, Justin Carrigan. Editors: Brenda Batten, Daniel Moss
To contact the Bloomberg News staff on this story: Kevin Hamlin in Beijing at khamlin@bloomberg.net
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