China Warns the U.S. to “Protect Investors”

The Financial Times (FT) reported today that China has warned the United States to “protect investors,”  and specifically the FT indicated, “China has called on Washington to bolster international faith in its economic  policies amid signs that Beijing has cut its purchases of US government debt.”

The implications are significant. China has been the largest buyer of U.S. Treasuries, and currently holds almost two-thirds of its foreign currency reserves of $3.2 trillion in dollar denominated securities, principally U.S. Treasuries. There is no question that America and the standard of living of Americans has been subsidized by the U.S. dollar being the principal global reserve currency, with the Chinese providng much of the funds.  While it is likely that the U.S. dollar will retain its status as a global reserve currency, its also likely that the percentage of global currency reserves held in U.S. dollars will decrease over time.  Without the Federal Reserve running the printing presses with a variation of QE3, it’s likely that U.S. interest rates will start increasing.

For some time China has been seeking to diversify its foreign currency reserves into a “basket of currencies,” following what is generally referred to as the Singaporean model,  The objective with the objective of reducing over time the percentage of its foreign currency reserves held in U.S. Treasuries.  Europe’s economic and financial problems, which were brought to the forefront of the global stage with the first Greek bailout as well as the inabilty of Europe to slow the contagion, have definitely been a hinderance to China’s desire to diversify away from the U.S. dollar.

With the outline of a deal in place between the U.S. Congress and the Obama administration, it will reassure global owners of Treasuries, including the Chinese, at least for now.  But, from a longer term perspective it’s not likely that the increase in the U.S. debt ceiling will do much to reassure global owners of Treasuries, due to the magnitude of U.S. governmental debt and the huge Federal budget deficit.

If Europe is able to resolve the debt issues of the peripheral European countries, the Euro will likely be the beneficiary of the diversification away from the U.S. dollar by the Chinese. While the Chinese view their holdings of foreign reserves as a state secret, it’s also generally acknowledged that the Chinese have been significantly increasing their holdings of gold.

For the full Financial Times article, go to http://www.ft.com/intl/cms/s/0/801bb3ec-b2b1-11e0-bc28-00144feabdc0.html#axzz1Seje7ELg

Author:  Jeffrey Friedland