A top Chinese official said Saturday the dollar represents a greater risk to the global economy than the yuan does.
Rather than monitoring the yuan, global financial institutions should watch the U.S. dollar, said Zhou Xiaochuan, the governor of the Peoples' Bank of China.
Later in an interview, Zhou said the yuan could rise at a faster pace, but that's not the Chinese way of economic reform.
"Probably it could be a little bit faster but it is not the way of Chinese reformers to do things," Zhou said in the interview.
Part of the US strategy of dealing with the trade deficit is to blame other countries. At the last G7 meeting, Treasury Secretary Snow told European countries the problem with world trade was sluggish European growth, not US over consumption. The US has made similar arguments to China - that China needs to increase domestic demand. Basically, the strategy is to blame everyone else for the basic problem of the US.
"Favorable conditions in the financial markets do not rule out the possibility of a sudden reversal in sentiment," Zhou said. The lack of coordination in the G7 on monetary policy "could result in large and volatile movements of financial markets."
"We cannot ignore the risk of disorderly adjustments in financial markets," Zhou said.
The US economy has a trade deficit of 7% GDP - a very large number. The US also has a budget deficit, largely because the "fiscally responsible" Republicans are in charge of national finances. Many economists have expressed concern over this figure, but Washington has yet to actually do anything about it.
Interest rate increases were the main reason the dollar appreciated in value last year. However, it appears the Fed is near the end of its rate tightening cycle. In addition, Japan and Europe appear to be closer to raising their interest rates, taking away the carry trade (borrowing at low rates in one country and lending long in another) which has helped finance the US housing market and overall economy.
Developing economy central banks have shied away from Treasury bond accumulation in the last year. According to the Treasury International Capital System, Japan has essentially levels it's holdings of US debt. Its holdings of government bonds decreased from 679 billion in January 2005 to 673 billion in February 2006. China increased its total US debt from 223 billion to 265 billion - an increase of 42 billion. For the last year foreign private individuals have been the largest purchasers of US Treasury securities. This places the dollar in a riskier position because private individuals will rapidly move away from US government obligations if returns are better in another market.
According to the International Monetary Fund's Cofer database total dollar reserves have increased from 881 billion in the first quarter of 1999 to 1.8 trillion in the fourth quarter of 2005 - an increase of 104% and a compound annual growth rate of 11.16%. Industrialized countries have leveled off their purchases of dollars in the first quarter of 2004, with totals fluctuating between 927 billion and 950 billion for the last 8 quarters. Developing countries have continued their purchase of dollars. However, these countries have more than doubled their dollar holdings from 423 billion in the first quarter of 1999 to 922 billion in the fourth quarter of 2005 -- the same level where industrialized countries leveled off their purchases. Developing countries do have different criteria for dollar accumulation. However, these countries already have a ton of dollars. The question is
"how much more are they willing to accumulate before they too start to level off their purchases?"
The Chinese central banker has a very good point: the dollar is in a risky position. Perhaps the US should put its own house in order before it starts to tell other countries how to run their economies.
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