By Hao Li: Subscribe to Hao's RSS feed
July 28, 2010 7:39 PM EDT
The gap – in terms of proportions – between how much dollar-dominated assets China holds versus how much China trades with the U.S. is quite large.
Stamford, Conn.-based Faros Trading estimates that China holds 65 to 75 percent of its foreign exchange reserves in dollar-denominated assets, for a total of roughly $2.5 trillion. However, only about 21 percent of its total trade business is with the U.S.
If China were to align its dollar foreign exchange reserve holdings with its U.S. trade, it would have to decrease it by 44 percent, or by about $1.125 trillion, according to Faros estimates. Putting it another way, China would be net sellers of $1.125 trillion worth of dollar-denominated assets.
Of course, China will do this slowly. Douglas Borthwick, managing director at Faros, compared the process to a small river that will eventually carve through granite.
Follow us
He thinks China will passively divest its dollar holdings by offering the market price levels at which they will sell the dollar assets and buy non-dollar assets. In other words, China will buy when others want to sell and sell when others want to buy. A by-product of this approach is actually increased liquidity in the market.
This adjustment, at whatever pace or method, will undoubtedly put steady pressure on the U.S. dollar. Indeed, Faros believes that there is a causal (not merely correlative) relationship between China's foreign exchange policy and the strength of the dollar, both versus the yuan alone and versus a basket of currencies.
Faros pointed out that when China de-pegged against the dollar in favor of a basket of currencies in July 2005, the dollar slid. When they re-pegged in July 2008, the dollar rallied strongly. In July 2010, when they once again reportedly switched to a more flexible regime, the dollar drifted lower.
Evidence
Weekly Roundup: Asian Markets Fall On Weak China Data And Euro Zone Debt Concerns
Pre-Market Movers (Frontline, EMC Corporation, Deutsche Bank, SAP, Carnival Corporation, Wells Fargo & Company and BHP Billiton Limited)
Asian Markets Fall On China And Euro Zone Concerns
US Stock Futures Point To Higher Opening FridayWe value your privacy. Your email address will not be shared.
Weekly Roundup: Asian Markets Fall On Weak China Data And Euro Zone Debt Concerns
