Delicate act of holding US Treasuries
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Since the moves of the US Federal Reserve System and Treasury Department have forced the dollar to decline, US Treasury bonds should have lost their charm. So, why does China continue to buy them?
China is the fastest-growing buyer of US Treasuries, and its foreign exchange reserves increased by $199 billion last year to reach $2.85 trillion. This has sparked concerns because there already is excessive liquidity in the Chinese market.
Yet China needs to hold the US Treasuries as an important way of safeguarding its economic security, given that the international financial order is dominated by the dollar.
Besides, the world's major financial institutions have given the Treasuries the thumbs-up sign in terms of security, liquidity, creditability and profitability. Going by this logic, China is justified in holding huge amounts of the Treasuries.
The question that arises is why Beijing is increasing its reserve of US Treasuries when it is beyond its reach to maintain its value, let alone make a profit out of them.
In a mature market economy, however, government departments should not take part in economic activities to make profit. And since China is leading its reform and opening-up on the basis of market economy, its departments, including the State Administration of Foreign Exchange (SAFE), should follow this rule.
The truth is that the SAEC, in essence, does manage the reserve assets to earn profit. Possibly, it does so because China's market economic system is not yet mature.
To secure earnings through reserve asset management, the authorities may find the following tips helpful. First, China can use US asset management experience for reference. Keeping its foreign exchange reserves on a reasonable scale, say, around $500-800 billion, the SAFE can entrust the rest of the reserve assets with specialized financial institutions that can invest them in profitable ventures. China has already accumulated some experience in this field. For instance, it has set up some commercial investment companies and a national sovereign wealth fund.
The advantage of such a move is that, compared with government authorities, commercial organizations have access to a wider range of profitable financial products.
The government, however, has to set up an assessment mechanism to determine and oversee whether such institutions can make profit. And it should let the media and experts help supervise their operations.
Second, to manage its Treasuries' reserve, China needs to take US interests into account. Correspondingly, the US should shoulder its responsibility of stabilizing its currency. They have to do this because the economic and trade relations between them are so close that neither can afford to jeopardize bilateral strategic partnership.
Third, given the record growth in China's foreign exchange reserves, it should now consider increasing its gold reserve.
In fact, after Lehman Brothers went bankrupt in 2008 and triggered the global financial crisis, China should have used more of its foreign exchange reserves to buy gold, especially because its gold reserve was relatively small at that time.
Although China has been increasing its gold reserve since 2003, it remains trivial compared with its massive foreign exchange reserves. And because China now faces the challenge of having large foreign exchange reserves, its monetary authorities have more than enough reason to increase the country's gold reserve.
If China continues to accumulate more foreign exchange reserves, the international gold price may soar. Hence, the fourth advice is that China should retain (or increase) its reserves of US Treasuries on a balanced scale, because a drastic rise in the international price of gold can cause serious harm to the US currency.
China is thus protecting US interests and the international monetary system, which is still dominated by the dollar, by increasing its reserve of US Treasuries. But China has to be cautious against holding excessive amounts of US Treasuries, because it has to bear part of the shock if the price of gold rises drastically.
Last, it is important for China to maintain harmonious international relations. The rapid expansion of China's economy has increased its influence in the global community. If China, as the top US creditor, dumps its Treasuries reserve, the international community will probably be forced to indulge in panic selling and thus trigger a dollar crisis.
Such a move can hurt relations between China and the US.
Besides, it would be inconsistent with China's diplomatic policies, and weaken the country's economy and security. Therefore, China should weigh the pros and cons carefully before it disposes of the US Treasuries.
The author is a research scholar with the Chinese Academy of International Trade and Economic Cooperation, affiliated to the Ministry of Commerce.
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