China - A snake with no venome (US Treasury Bonds)

[Gladiator]

Dear All,

i had come across this article in ET , i have few qestion whihc i marked in BLUE which i have unable to understand or i have less information about it .

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Vishal

DRAGONS $2.4-TRILLION WEAPON

BEIJING IS LIKELY TO USE ITS FOREX RESERVES TO MAKE WORLD TRADE SERVE ITS INTEREST

CHINA disclosed the other day that its foreign exchange reserves had increased to about $2.4 trillion in 2009, a gain of $453 billion for the year. These stupendous figures and the likelihood that the countrys reserves will rise by a comparable amount this year have now become a financial, economic and geopolitical reality of surpassing significance.

The significance is not, as many imagine, that China might suddenly dump the dollar and dethrone it as the worlds major international currency, undermining American economic power and prestige.

Two-thirds or more of Chinas reserves are estimated to be held in dollars.
As an economic strategy, dumping the dollar would boomerang . It would amount to a declaration of economic war in which everyone Chinese, Americans and many others would lose.

Consider what would happen, hypothetically.,

China would first sell securities in which its dollars are invested.
This would include an estimated $800 billion in US Treasury bonds and securities, plus billions of American stocks and corporate bonds.

After unloading the securities and collecting dollars, it would sell the dollars on foreign exchange markets for other currencies: the euro, the yen and who knows what else.

The massive disgorging of dollars could trigger another global economic collapse.

As Chinas selling became known, other foreign and American investors might jump on to the bandwagon, abandoning dollar securities and shifting currencies. If panic ensued, markets would fall sharply. Banks and investors would see their capital and wealth erode.

The resumption of the global recession, even depression , would shrink foreign markets

for Chinas exports in 2009, its exports fell 16%. To protect jobs, other countries might impose quotas or tariffs on Chinese imports.

Why would China do this to itself The answer: it wouldnt .

Look elsewhere for the significance of the huge foreign exchange reserves. For starters, they confirm Chinas mercantilist trade policies. A country that practices mercantilism strives to increase exports at the expense of its trading partners.

China has done this by keeping its currency, the renminbi, at an artificially-low rate that gives its exports a competitive advantage on world markets.( is it Advisible? If YES, Why can't India Do this? Postive and Negative of this strategy.)

Huge trade surpluses have resulted, although last years surplus declined as a result of the global slump.

Its often said that the US borrows from China, because the Chinese hold so many Treasury bonds. This inaccurately describes reality.

When China receives dollars, it could use those dollars to buy imports. Or it could limit the dollar inflow by allowing the renminbi to appreciate, making its exports more expensive and its imports cheaper.

In 2005, China began a modest appreciation of the renminbi against the dollar; in mid-2008 , it stopped. Since then, the renminbi has depreciated against many currencies, reports economist Nicholas Lardy of the Peterson Institute. In 2010, Lardy expects the trade surplus to grow. So, China accumulates dollars, which must be invested.

The large surpluses cause China to lend to us and other countries, regardless of whether we want the loans .

Even if China had no trade surplus, its foreign exchange reserves would probably grow because it receives earnings on its existing reserves. These reserves serve other Chinese strategic purposes .

Theyre used to make investments in raw materials oil, food and minerals and important technologies around the world; or they buy political influence with foreign aid or favourable loans. In effect, China has a $2.4-trillion stash to use as it pleases. The irony: despite complaints about big Treasury holdings, these holdings advance Chinas economic aims of job creation through exports and protection against scarcities of vital commodities. The underlying purpose is to bolster the governments grip on power by ensuring rapid economic growth. Granted, China is tying to generate more growth from domestic spending; still, it is promoting strong exports until that happens.

But whats good for China may not be good for the rest of the world, including the US.

Its not simply a redirection of economic power but a question of how that power will be used, consciously or unconsciously, to shape the global economic order.
Lopsided economic expansion poses many dangers. Already, Chinas huge reserves invested in US bonds are cited as one reason for the low interest rates that brought on the financial crisis. The artificially-depressed renminbi hurts exports from developing countries and not just the US, Europe and Japan. (why they not taking any action ? if yes .. which one ?)

China grows at others expense. The manipulation of trade subverts support elsewhere for open trading policies. For now, China has no desire to substitute the renminbi for the dollar as the primary global currency .

Its ambition is more sweeping: to create a world economy that serves Chinas interests and, only as an afterthought, anyone elses ( what WTO is doing ?)

Source . Economic times .26 Jan 2010