China, Japan holdings key to dollar health
December 9, 2004
New York - With hundreds of billions in dollar holdings, China and Japan could provoke a global financial crisis if they start to cash out, but experts see this as unlikely.
Recent US Treasury figures showed that Japan had some $720 billion in US bonds - or about one-third of the total $2.23 trillion outstanding - and China held $174-billion worth as of late September.
Experts point out that this accumulation of dollar holdings has kept the greenback from collapsing and has effectively subsidised US consumers by keeping interest rates low.
But a halt to US bond accumulation or a liquidation of these holdings could send shockwaves through financial markets and lead to a precipitous drop in the dollar that could result in a global calamity.
David Solin, a currency analyst at FX Analytics, is aware of the potential for disaster but sees the risk as remote.
"I think there is very little chance of it," he said.
Japan and China "are both well aware it is in their own interest" not to liquidate dollars, which could hurt the United States economy, "still the main world growth engine."
However, there are some signs of concern. Over the first nine months of the year, Chinese bond purchases were up 11.3 percent, only about half the rate of increase of 2003.
Sung Won Sohn, chief economist at Wells Fargo, said he does not see a brutal sell-off in Asian dollar holdings, but perhaps a more gradual reduction of "a billion here, a billion there."
Some experts suggest that a gradual, managed decline in the dollar may be positive by reducing the US current account deficit and possibly boosting growth elsewhere.
But some point out that a more brutal adjustment cannot be excluded.
"Any country that runs the kind of trade and budget deficits that the US currently has must worry that one day those debts will result in a currency crisis, inflation and higher interest rates," said Wachovia Securities analyst Rod Smyth.
"In the event of a dollar crisis, in our view, everyone loses. US prices rise, the Fed is forced to combat the resultant inflation with higher interest rates, and US demand falls hurting its trading partners."
Smyth said this is not likely but a scenario that has to be monitored.
"The dollar's decline is not over. We think the decline will be orderly and a dollar crisis will be averted by significant Asian intervention and possibly lower European interest rates because of global self-interest. However, a US dollar crisis cannot be completely ruled out."
Sohn said foreign investors will not keep pouring money into the United States if the dollar continues to fall.
"After home country inflation is factored in, real returns (for foreign investors in US bonds) quickly approach zero or turn negative. This is a strong incentive for foreign investors to cool their buying and cash-out some of their stakes in the US," he said.
"Foreign capital inflows could quickly dry up. In short, the dollar depreciation is likely to continue and could intensify further, before stability is finally achieved."
China is now seen as a key to how the currency adjustment is managed and is being pressed to adopt a flexible monetary policy, ending its decade-old peg to the dollars.
But Chinese Premier Wen Jiabao said recently that Beijing would not be rushed on this and said Washington needed to put its own house in order.
"We have to ask a question. The US dollar is depreciating and it is not managed," he told reporters last month. "Shouldn't the relevant parties adopt measures?" - AFP
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