Can US ensure the safety of China's assets?

China's holdings of US Treasuries rose by $12.2 billion in January to $739.6 billion, representing 6 percent of the US government's debt, and further consolidating China's status as the US's biggest creditor.

At a press conference in March, Premier Wen Jiabao expressed concern about the safety of China's dollar-denominated assets. A White House spokesperson later responded with reassurances that Treasuries remain one of the safest investment options in the world.

However, the Federal Reserve announced on March 18 that it will buy up to $300 billion in long-term Treasuries and spend as much as $750 billion in additional mortgage-backed securities.

Can the US ensure the safety of China's assets? Experts gave different answers on the website of Caijing magazine.

Yes

Ha Jiming, chief economist of China International Capital Corporation (CIC):

In the short term, US Treasuries remain one of the top choices for China to invest its foreign exchange reserves in.

Although there are doubts about whether the dollar can maintain its status as the international reserve currency, it will be bolstered by such factors as even worse economic performance in Europe, Japan and the emerging markets, and the prevailing market sentiment for avoiding risks.

As other currencies are losing their value against the dollar, buying Treasuries is a reasonable investment choice for China. Investors will suffer exchange losses if they invest in other currencies. China should buy the Treasuries as early as possible.

Shen Jianguang, PhD, China International Capital Corporation (CIC):

Safety is foremost in China's foreign exchange reserve management, followed by liquidity and profitability.

Generally speaking, government debts are the safest investment choice, and US Treasuries usually are of the lowest risk because the US government is the least likely of all governments to go bankrupt.

As for liquidity, neither gold nor oil offers the same kind of liquidity as the dollar. Nowadays financial products have become highly risky, partly because of the panic caused by the ongoing financial crisis. Risk awareness also explains why investment continues to flow into the US even though the Treasury yields are at historic lows. At least, the US government will not default on its debt, since the Fed can pay off the debt simply by printing more money.

Once assured of payment, creditors can think about the yields on their investment. If inflation occurs in the US, the price of the Treasuries will fall on the bond market, which creditors like China are unwilling to see.

If the dollar depreciates, China's dollar-denominated assets will be less valuable. The biggest threat to the US economy now is deflation, instead of inflation.

The Fed move can be interpreted as a way to help fight deflation. Their buying of Treasuries has two functions: One is to reduce yields on long-term Treasuries, which will help lower the interest rate on mortgages and thus stimulate the housing market. The other is to create an expectation of inflation in the market, which, if controlled to a certain degree, is good for the US economy.

Apart from the Treasuries, China can also spend its foreign exchange reserves on oil, minerals and raw materials, but the quantities purchased will be subject to certain limitations. For instance, the amount of oil that can be purchased will depend on the number of oil storage tanks in the country.

No

Shen Minggao, chief economist with the business and financial magazine Caijing:

I doubt the US government's ability to ensure the safety of China's investment in Treasuries. At least for the present, Washington has nothing to assure us on.

What the US government can guarantee is avoiding credit risk - it will not default on its debt. But that cannot provide any shelter for investors to avoid inflation, the depreciation of the dollar or risks in liquidity. These pose major threats to China's holdings of Treasuries with maturities longer than a year.

Whether inflation will hit the US is out of Washington's control. All we can do is to hope the Fed will tighten the liquidity of greenbacks when there are signs of inflation.

There are a lot of uncertainties, especially when the Fed has injected liquidity into the market by buying securities backed by low rated assets. Whether these assets can be redeemed at their original prices is still up in the air.

The dollar may also depreciate significantly. The reason why the dollar remains strong is that prudent investors are reluctant to invest in non-dollar assets that are highly risky during a global financial crisis.

Once the world economy stabilizes and the US economy does not see a vigorous rebound, investors will be more active in buying non-dollar assets, which will result in the depreciation of the dollar. Of course, investors will remain interested in the dollar if the US economy sees a strong recovery.

Jin Pai, independent analyst:

The Fed move to buy up to $300 billion in long-term Treasuries will increase inflation risk. This would subject China's foreign exchange reserves, 70 percent of which are dollar-denominated, to such risks as devaluation and falling yields.

The Chinese saying goes, "A wise man stands away from a collapsing wall." China should buy no more of the Treasuries. Anyway, China is not America's savior as its holdings only account for some 6 percent of the US debt.

On the other hand, China's gold reserve is too low. China should increase its gold reserve to gain a bigger say in the international monetary system. Obstacles in purchasing resources do exist, but we can buy stakes in businesses that deal in resources. Aluminum Corp of China's offer to invest $19.5 billion in global mining giant Rio Tinto Group is an example in this regard.

China can also purchase technology patents to support domestic research and manufacturing enterprises in the high-tech sector. It will help Chinese enterprises upgrade their technologies, sharpen their competitive edge and raise their profit margins.

(China Daily 04/13/2009 page2)