More Incoherent Remarks From China on Its Dollar Holdings

Dean Baker has regularly made fun of the idea that the Chinese are concerned that they will show losses on their large dollar positions, mainly invested in US Treasuries. As serious traders will tell you, it’s actually easy to manipulate a market, but hard to make money doing it. As Baker put it:

The argument that China is worried that it will lose money on its dollar holding because of a fall in the value of the dollar implies that the Chinese are morons. There can be no doubt that the dollar will fall and that the Chinese will lose money on their dollar holdings. The only thing that keeps the dollar from falling now is the decision by the Chinese government to buy hundreds of billions of dollars a year. Of course China can keep the dollar from ever falling as long as it is prepared to buy ever more dollars, just as it could have kept shares of Pets.com at $100 if it continually bought more shares. (By the way, the dollar will fall because of our trade deficit, not the budget deficit. If we had the same trade deficit and the budget was in surplus by $1 trillion a year, the dollar would still fall.)

The only plausible story for China’s buying of vast amounts of dollars is to support its export market to the United States. It could do much better investing its surplus in euros, yen, or almost any other currency in the world or just about any commodity. China knows it will take a bath, arguing otherwise is saying that the Chinese leadership is stupid.

Yves here. Um, an article at Bloomberg tonight suggests that the Chinese are stupid, or maybe crazy like foxes. If they can convince us to buy this barmy argument, that their certain losses on their currency manipulation are somehow our problem, then they can extract some completely unwarranted concessions from us.

From Bloomberg:

U.S. Treasuries fail to provide safety or liquidity when it comes to managing China’s $2.45 trillion foreign-exchange reserves, said Yu Yongding, a former central bank adviser.

“I do not think U.S. Treasuries are safe in the medium- and long-run,” Yu, a member of the state-backed Chinese Academy of Social Sciences, wrote yesterday in an e-mailed response to questions. China is unable to sell the securities in a “big way” and a “scary trajectory” of budget deficits and a growing supply of U.S. dollars put their value at risk, he said….

“China has to depend more on demand and supply in the foreign exchange market for the determination of the yuan exchange rate,” Yu wrote. “Only God knows how much value that China has stored in the U.S. government securities will be left in the future when China needs to run down its reserves.”

Yves here. Let’s be clear. These holdings were accumulated as part of a trade policy. Currencies of developing countries generally rise as they become more prosperous. China has deliberately kept the value of its currency artificially cheap by buying dollars. Losses were inevitable, so the Chinese caviling is misguided.

Yu’s comment about the illiquidity of China’s Treasury position is accurate but equally wrongheaded. Take a big enough position in ANY instrument, no matter how actively it is traded, and you will not be able to exit your position quickly without depressing the market, as LTCM learned painfully when its interest rate swap bets constituted 10% of the market and it desperately wanted to reduce them.

But expect this sort of thing to come up with increasing frequency as frictions between the US and China rise. Unfortunately, enough people in both countries seem to buy into this faulty argument to assure it a continued hearing.


Originally published at naked capitalism and reproduced here with the author’s permission.