Dollar assets hard to diversify, Chinese FX official admits


From Reuters
Saturday, November 25, 2006

BEIJING -- Countries holding large stockpiles of foreign exchange reserves face problems diversifying their holdings away from dollar-denominated assets because of the potential market reaction to any such move, a senior Chinese forex official said on Saturday.

The official, Guan Tao, deputy director-general of the general affairs department of the State Administration of Foreign Exchange (SAFE), highlighted the potential pitfalls of such a move without specifically referring to China or its plans for managing its reserves.

"It is very difficult for these countries to make significant adjustments in their reserve asset portfolios," Guan told a forum, adding that that was his personal view and not a statement of SAFE policy.

"As we all know, every move by these countries in the market is under the spotlight," he said. "Once you say 'forex reserve currency diversification,' regardless of whether you're talking about the past or the present, there will definitely be market reaction."

A growing chorus of Chinese government economists has begun calling for Beijing to shift some of the country's reserves, the world's largest at more than $1 trillion, away from dollar assets and into other currencies or strategic resources such as oil.

The composition of the reserves is a state secret but bankers and academics assume that at least two-thirds is invested in dollars, mainly U.S. government debt.

The role of the United States in world trade meant that it and major holders of foreign exchange had formed a mutually dependent relationship, said Guan.

"The U.S. buys cargo, and countries with a trade surplus buy U.S. treasuries -- they actually have no other choice," he said.

"If I have a surplus on the trade account, if I have foreign exchange income, I can certainly invest part of it in non-dollar assets, but the size of the market for non-dollar assets is very limited, so the great majority of foreign exchange reserve assets has to be invested U.S. financial markets."

Therefore, it was very unlikely that currency markets would see any massive selloff of dollars by countries with large reserves, Guan said.

"Given that U.S. dollar liquidity is currently mainly held by a few monetary authorities, we feel that the possibility of a big fluctuation in the dollar is very small -- at least for now," he said.

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