Straits Times (Singapore) 29 January 2005
What if China shuns US dollar?
By William Pesek Jr
MALAYSIA isn't a place traders look to for clues about the United States currency, yet Asia's No. 10 economy may offer some ominous ones. -------- PEGGING TO EURO, YEN: Chinese economist Fan Gang created a stir when he said China has lost faith in the US dollar, and mentioned the possibility of moving from a US dollar pegging to 'a more manageable reference, say, euros, yen'. -- REUTERS -------- They can be found in a recent report on international reserve holdings at Bank Negara Malaysia, the nation's central bank. It states that Malaysia made a US$2.1 billion (S$3.4 billion) 'revaluation gain' last year, 'arising mainly from the depreciation of the US dollar against the major currencies'.
One can't help but wonder if Malaysia is buying an increasing amount of euros - or even yen - these days. Its central bank sure didn't make that kind of cash holding the dollar, the currency to which its own, the ringgit, is pegged.
The plot thickens when you consider how such a shift away from the dollar would jibe not only with comments from top Malaysian officials, but also with trends throughout Asia.
In Malaysia, for example, Prime Minister Abdullah Ahmad Badawi recently said he is seeking ways to reduce the economy's reliance on the dollar for trade. Indonesia has said it is considering trimming its holdings of US Treasuries. The same goes for Thailand, according to the Financial Times.
Traders speculate that China may pull the plug on dollar-denominated debt. Such a move by the second-biggest holder of US Treasuries after Japan could send shockwaves through global markets.
Greenback 'not stable'
HENCE, all the fuss over comments by Chinese economist Fan Gang. Mr Fan is not a government official. He is director of the state-owned National Economic Research Institute in Beijing.
The connection seemed close enough for traders, who found great relevance in his comment that China has lost faith in the dollar.
'The US dollar is no longer... (seen) as a stable currency and is devaluating all the time, and that's making trouble all the time,' Mr Fan said, speaking in English at the World Economic Forum in Davos, Switzerland.
'So the real issue is how to change the regime from a US dollar pegging to a more manageable reference, say, euros, yen, dollars - those kind of more diversified systems.'
Mr Paul Donovan, London-based senior global economist at UBS AG, seemed to speak for many traders when he said: 'This is a scenario we consider to be highly likely.' Certainly more likely than, say, China letting the yuan trade freely.
The US has been using its might to bully China into revaluing the yuan. Yet it seems it is US weakness - a fragile dollar - that may be the catalyst.
Turning to the euro
IT MEANS now is as good a time as any for this region to avoid losses ahead of any surge in US debt yields.
After all, in real estate, it is all about location, location, location. With markets, it's timing, timing, timing, and waiting means Asian central banks may lose even more.
Confidence in the dollar wasn't enhanced this week by President George W. Bush's record budget deficit forecast of US$427 billion for this fiscal year. It belied assurances that the White House will bring one of the world's most worrisome economic imbalances under control.
All this has investors turning to the euro. Once Asian central banks do so, the dollar's woes will worsen.
By buying vast amounts of Treasuries, Asian central banks are delaying the rise in US yields that typically accompany a falling currency. If Asians pull the plug, US rates may skyrocket.
Central banks here don't buy US debt out of altruism. Hoarding dollars is necessary to hold down currencies to boost Asian growth. Yet, dumping dollars will result in stronger Asian currencies and, by extension, Asian gross domestic product.
Smaller economies like Malaysia or Thailand may be able to trim dollar holdings without undermining their own economies. The same can't be said of Japan and China. Combined, they own US$906 billion of the US$1.1 trillion in US Treasuries held overseas.
Warning signs
STILL, the day of financial reckoning investors fear may be getting closer. It has been said Japan's bond market is a bubble waiting to burst. Even with a national debt approaching 150 per cent of GDP, 10-year Japanese debt yields just 1.32 per cent.
Asians have to wonder if US rates are irrationally low, too. Do yields at 4.19 per cent for US 10-year debt really compensate investors for the risks they face?
The US finds itself in a 'be-careful-what-you-wish-for' situation here.
If China announces tomorrow it will let the yuan float, as the US wants, its central bank won't need anything near the US$191 billion of US debt it holds. Massive dollar selling may follow.
Asian central banks, like China's, have become the US' bankers, financing its excesses through good times and bad. It is now up to Asia to de- cide whether to extend that line of credit. The US should be warned that the odds are moving less and less in its favour. -- BLOOMBERG
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