By Bill Wilson – China may be preparing to cut its foreign exchange reserves by about two-thirds, down to about $1 trillion from its current $3.04 trillion level, according to Chinese news service Xinhua.
Why? China simply has too much money, according to Zhou Xiaochuan, the head of the People’s Bank of China. “Foreign-exchange reserves have exceeded the reasonable level that our country actually needs,” he recently said.
Zhou noted that China’s stockpiling cash is “feeding inflation and becoming difficult to manage”. To be certain, China is suffering from an inflation problem, already up over 5 percent, not to mention a tremendous real estate bubble that threatens its very financial system. It needs to figure out a way to restore price stability.
So, Zhou wants to diversify the country’s assets of foreign exchange holdings, an obvious target.
Zhou’s sentiments were echoed on April 23 by Tang Shuangning, chairman of China Everbright Group, who wants the reserves be restricted to between $800 billion to $1.3 trillion and the rest of the money reinvested.
Tang “suggested five channels for using the reserves, including replenishing state-owned capital in key sectors and enterprises, purchasing strategic resources, expanding overseas investment, issuing foreign bonds and improving national welfare in areas like education and health,” writes Xinhua.
Zhou and Tang were not alone. Xia Bin, another Chinese central banker suggested that $1 trillion of foreign exchange reserves would be sufficient. He too called for the reserves to be used more “strategically” to acquire hard resources and technology for the Chinese economy.
This would be a marked change in Chinese policy, which has been to stockpile these reserves, in particular dollar-denominated assets. It currently holds about $1.154 trillion of U.S. treasuries — the debt securities that constitute U.S. debt.
Now it may be planning to dump those U.S. treasuries on the market. If China wants to diversify its holdings by reducing its gross reserves by two-thirds, that would necessarily mean a drastic reduction of its share of the $14.3 trillion U.S. national debt.
This would have severe consequences, mostly for the American people.
Because the U.S. has racked up so much debt among foreign creditors like China, we have become increasingly vulnerable to their whims. China dumping a significant portion of its U.S. treasuries could spark a run on the dollar, uprooting it as the world’s reserve currency. How?
It would cause a rush to the exits on the treasuries market, robbing the ability of the U.S. to borrow from other creditors, who would not want to risk having the value of their assets devalued. Suddenly, a frenzy would occur by financial institutions to cash in dollars for something — anything — of value.
A dollar run would in turn cause hyperinflation here at home, super-high interest rates, and a complete default on U.S. debt. Without borrowing, we lack the ability to repay principal and interest owed on the national debt. We really are that vulnerable.
But, wouldn’t China be devaluing its own assets? Zhou does not seem to think so. He thinks his country needs to stop stockpiling money to get domestic inflation under control. But even if the Chinese were not looking to dump current holdings — they may still be signaling that they won’t be looking to buy any more.
With the Fed supposedly out of the Treasury market come June and with them now buying 70 percent of the issues, who will buy this junk? Barack Obama sees trillion dollar deficits for the next decade. At best, China can just sit back and do nothing and seriously injure us.
At worst, China may want to get out while the getting’s good from what amounts to nothing more than a useless paper trade.
After all, the alternative may be to wait for somebody else to start cashing in their dollars first. In this high stakes game of musical chairs, China may not want to be left without a chair when the music stops.
Bill Wilson is the President of Americans for Limited Government. You can follow Bill on Twitter at @BillWilsonALG.