China needs to preserve value of its savings

[Commonground]

2010-03-19
By Yu Yongding (China Daily)
[Yu Yongding, president of China Society of World Economics, is a former member of the monetary policy committee of the Peoples' Bank of China.]

Before the global financial crisis hit, critics of China's economic imbalances - its twin fiscal and trade surpluses - mainly concentrated on the misallocation of resources that occurs when less-developed countries borrow from richer countries at high interest rates and lend the money to them at low interest rates.

The great irony of the financial crisis is that the situation has actually become worse, not better.

China needs to preserve value of its savings

China's foreign-exchange reserves, indeed, are facing a triple whammy: a decline in the US dollar's purchasing power, a fall in the prices of US government securities, and possible inflation in the longer run.

The bulk of China's $2.3 trillion in foreign reserves are held not for the purpose of protection against negative external shocks, but as savings in the form of US Treasury notes. China thus needs to preserve the value of its savings.

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http://www.chinadaily.com.cn/cndy/2010-03/19/content_9611918.htm

 

[Commonground]

Re: China needs to preserve value of its savings

An excerpt from the article:

Unless the Fed successfully implements an exit strategy from monetary expansion, which is doubtful, China will not be able to recover its losses. A less likely but more damaging scenario is that all the money dropped on the economy by US Federal Reserve Chairman Ben Bernanke will eventually stoke a bout of serious inflation.



If this nightmare comes true, China's packed savings in the form of US government securities (which now amounts to some $900 million in Treasury bills alone) will simply go down the drain.



Despite China's limited room for maneuver with regard to its stocks of foreign-exchange reserves, it should never give up its efforts to safeguard the value of its hard-earned wealth, which has been entrusted to the good will and supposedly responsible hands of the US government.



As the stronger and more experienced party, the US can help to allay China's fears about the safety of its national savings. For example, the US government should offer more financial instruments like Treasury Inflation-Protected Securities (TIPS), thereby allowing China to convert some of its holdings of US government securities into similar but safer assets.



Furthermore, China should be allowed to convert part of its foreign-exchange reserves into assets denominated in the International Monetary Fund's special drawing rights (SDRs). Of course, China should not rule out the possibility of adjusting the composition of its foreign-exchange reserves to mimic the composition of the SDR.
Finally, if the US government cannot safeguard the value its securities, it should compensate China in one way or another. Only then can China and the world be certain that America's irresponsible attitude - "the dollar is our currency, but your problem" - has become a thing of the past.