China's premier on China's dollar holdings

China's premier, Wen Jiabao, answered several reporters' questions last Friday.  Because China's holdings of US dollar assets seems to be on everybody's radar, I thought this exchange with the Wall Street Journal would be of interest.

Wall Street Journal [excerpt]:

...the government has announced plans for a new agency to manage the diversification of China's foreign exchange reserves. Can you tell us what kind of assets this agency will invest in?

China's Premier Wen Jiabao [excerpt]:

In the 1990s, China did not have enough foreign exchange, so we borrowed foreign exchange from the IMF. The IMF only lent us $800 million. Now our foreign exchange reserves have exceeded $1 trillion, and how to make good use of them has become a new issue for us. 

China practices diversification of its foreign exchange reserves to ensure their security. Yes, we do plan to set up a foreign exchange investment company, and it will not be under any government department... It will be under government oversight and regulation and should preserve and increase the value of the assets... 

I know by raising this question, you may wonder whether the overseas investment to be made by this newly established agency will affect US dollar-denominated assets. China's foreign exchange reserves mainly consist of US dollar denominated assets. This is the fact. China's holding of US dollar denominated assets is mutually beneficial in nature. The setting up of a Chinese foreign exchange investment agency will not affect the US dollar-denominated assets. [emphasis mine]

It wouldn't be logical for China to invest their dollars in a way that diminishes their value.  As some have been trying to point out, even if that were feasible, it would be the financial equivalent of shooting oneself in the foot, or worse.  It just wouldn't be logical. 

I do understand that logical economics isn't always what drives politicians; however, the massive worldwide market in dollar-denominated assets will make it difficult if not impossible for any single country, including China, to dent the dollar by much—even if its politicians were willing to risk shooting their country's foot off.  [In fact, I think the only country in the world whose politicians might be able to pull that off is the USA.]   

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For reference, if you haven't seen it already, here's a recent chart showing how much of our federal debt is held by China and other entities.

Comments

[Dr. Ron Paul]

Dr. Josephe Salerno on myths about Gold standard

http://mises.org/MultiMedia/video/Salerno/Salerno10.wmv

Dr. Salerno is a libertarian economist from the Austrian School

[Robert Schwartz]

The great thing about the Chinese owning about T$ of Treasuries is that the securities are a bond for their good behavior. Launch an attack on Taiwan and we cancel them.

[Bob]

"It wouldn't be logical for China to invest their dollars in a way that diminishes their value."

It would if the Chinese think the dollar is likely to crash and want to reduce their exposure.

They might look at the trade deficit that the USA had had since the 1970's, the 44 sub prime mortgage lenders that have collapsed or been sold for a song in the last six months and consider just how badly the US financial system will be hit when house prices drop, lots of borowers default on morgagues and that goes back up the chain to the institutions that planned on getting a good return on money lent out for mortgages. Hedge funds are going to go down like dominos.