CANCELING AMERICA’S CREDIT CARD

CANCELING AMERICA’S CREDIT CARD

It has only been three months since Chinese Premier Wen Jiabao demanded that the United States “guarantee” the safety of China’s massive holdings in U.S. dollar. The amount of China’s dollar holdings is unclear but estimates vary between 70 percent and 82 percent of China’s two trillion dollar mountain of foreign reserves.
As Premier Wen explained in March, "We have lent a huge amount of money to the U.S. Of course we are concerned about the safety of our assets…To be honest, I am definitely a little worried."
Wen didn’t get his guarantee from the Obama administration which continues to pile up debt. China last spoke out on the dollar later that month when Zhou Xiaochuan, the governor of China’s central bank, said the time had come to end the dollar’s reign as the world’s reserve currency before a G-20 meeting.
With little response from Washington or the rest of the developed world, China has been moving quietly and cautiously away from the dollar. In order to avoid setting off a panic, China has been hedging its holdings and diversifying in a number of ways. Recently we told you about China’s increasing gold reserves, but gold is believed to make up only two percent of China’s total reserve hoard.
As the dollar began falling due to concerns about America’s AAA debt rating, China quietly began taking the first steps to make the yuan a more convertible currency. The most significant is a decision by the State Council (China’s Cabinet) to enable selected importers in five of China’s largest cities to settle cross-border trades through Hong Kong in yuan. In Shenzhen alone 100 companies have been selected to trade in yuan.
Beijing followed up by selecting two banks with an enormous presence in Hong Kong to sell yuan bonds. HSBC Holdings and the Bank of East Asia will be allowed to sell bonds denominated in yuan in a move that is widely seen as furthering Beijing’s goal of promoting the yuan as a recognized alternative to the U.S. dollar for international trade and for reserves.
Hong Kong may be first in line to become a yuan trading hub, but Beijing is acting rapidly to spread the yuan throughout Asia. China’s central bank has signed agreements to lend yuan to South Korea, Malaysia, Indonesia as well as Belarus and Argentina. It’s expected that Beijing will ultimately allow yuan trade throughout the ASEAN trading bloc, another step on the road to becoming a widely accepted trading currency.
While promoting the yuan, China has been taking subtle steps to reduce its reliance on U.S. debt instruments. Dumping the dollar would be self defeating for the Chinese but Beijing has been selling off the debt of government sponsored enterprises like Fannie Mae and Freddie Mac to buy treasuries, and not just any treasuries.
The stark fact is that China is selling its long-term Treasuries for short-term notes and Treasury bonds. By sticking to short-term instruments, China is improving its options to liquidate dollars relatively quickly in favor of other reserve currencies such as the euro or the yen.
As the co-chair of the House Appropriations Committee, Representative Mark Kirk remarked, “It would appear, quietly and with deference and politeness, that China has cancelled America’s credit card. Kirk says not very many people on Capitol Hill realize this is now happening.
So, if you hear politicians try to reassure the American public that China remains the top buyer of U.S. Treasuries, keep in mind that China’s buys are not new money. China is merely rotating its large holdings of short term Treasury bonds and notes much more frequently. There is no indication whatsoever that China is selling off euros and yen to buy larger dollar reserves.
Don’t expect dramatic moves from Beijing, despite an alarmist prediction by famed economist Nouriel Roubini that the yuan was positioned to usurp the greenback as the world’s reserve currency. Beijing would indeed enjoy the prestige and flexibility that comes with that privilege, but that won’t happen quickly. Beijing’s problem is that the yuan would be a strong, attractive currency, considering China’s reserve holdings and its important trade position. That would means its value would rise if it were traded freely. And if the value of the yuan went up, China’s beleaguered export industries would suddenly become less competitive. Beijing won’t let that happen.
The vice-head of China’s Banking Regulatory Commission acknowledged the many barriers that remain before Beijing would meet all of the conditions to allow the yuan to become an international reserve currency. The commissioner did allow that the yuan could make up more than three percent of global foreign exchange reserves by 2020.
Without doubt, that is a conservative estimate considering the speed at which Beijing is spreading the usability of its currency throughout Asia and the world.
Just as the Chinese are doing, it makes sense for investors to diversify internationally to hedge against fluctuations in the dollar and the U.S. economy.