World starting to sense that too many dollars are floating around


China's Reserves Spur Policy Debate

By Elaine Kurtenbach
Associated Press
Tuesday, November 28, 2006

Speculation over China's plans for its $1 trillion in foreign reserves is rattling global currency markets, while fueling a lively debate back home over how Beijing should use its unprecedented wealth.

China's central bank, the People's Bank of China, refused comment Tuesday on rumors that Beijing is shifting its foreign reserve holdings away from U.S. Treasuries, speculation that helped push the dollar sharply lower in currency markets Monday.

"Please take our vice governor Wu Xiaoling's speech as a reference," said an official at the central bank's press office. Like many Chinese bureaucrats he gave only his surname, Cheng.

Speaking at a conference in Beijing on Friday, Wu reportedly noted the risks for East Asian holders arising from the U.S. dollar's decline against other currencies, triggering a spate of dollar selling that added to its recent declines.

After slipping to a three-month low on Monday, the dollar recovered slightly against the Japanese yen on Tuesday to 116.10 yen. The dollar also edged up from Monday's 20-month low against the euro.

The dollar's decline has had a limited impact on the value of the Chinese yuan since daily movements in the dollar-yuan rate are capped at 0.3 percent above or below the official level announced by the central bank each trading day.

The yuan began trading Monday at a record high against the dollar after the central bank set its official level at 7.8402, the highest level since the current trading system was set up in July 2005.

But the yuan retreated Tuesday. It was quoted at 7.8465 on the over-the-counter market late in the day, compared with 7.8436 on Monday.

Still, markets ravenous for trading cues are on constant alert for any sign China is losing its appetite to accumulate dollars as a reserve currency.

Beijing will not confirm details regarding the size and composition of its foreign reserves, which are thought to have already exceeded $1 trillion after officially hitting $987.9 billion by the end of September.

But Gov. Zhou Xiaochuan and other central bank officials have acknowledged China's intention of gradually diversifying dollar holdings to include more yen and euros. Purchases of assets denominated in other currencies reportedly have risen.

But most experts downplay the possibility of Beijing suddenly dumping its dollar holdings.

"Diversifying foreign reserves is a natural part of development, but it doesn't amount to simply reducing U.S. dollar assets," said Li Daokui, a professor of economics and management at Beijing's Tsinghua University.

"The U.S. dollar is undoubtedly still the strongest and most reliable support for the Chinese currency market," Li notes. "We can't simply give up on the U.S. dollar."

The bigger issue for many economists is how Beijing should use the massive wealth it has accumulated thanks to China's longtime tendency to save more than it spends: the $1 trillion pool amounts to roughly 40 percent of China's projected gross domestic product this year, or half of all Asian reserves.

"What really counts is how to effectively manage foreign exchange reserves," Li Xianrong, a researcher at the government-affiliated Chinese Academy of Social Sciences, wrote in Tuesday's edition of the state-run newspaper China Daily.

Some economists, such as Yiping Huang at Citigroup, argue that China should use some of its reserves to help fund cash-starved social and educational programs. Although the reserves can't be directly transferred like tax revenues, the Finance Ministry could issue long-term bonds to the central bank in exchange for a part of the reserves, he says.

Raising spending on such programs would reduce Chinese families' strong incentive to put such a large share of their income into savings to pay for health care, education and other needs, advocates of the approach say.

"To keep the economy growing at 8 percent to 10 percent a year, China needs to do more to stimulate consumption," says Huang. "With better social welfare programs people would feel more comfortable and spend more."

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