China Owns Too Many Dollars

One of my favorite articles over the last several years was "The $1.4 Trillion Question" from the Atlantic Monthly. It discussed how the Chinese were amassing huge amounts of dollar denominated assets, and asked the question "what will happen next?" or maybe "what might go on to get the Chinese to be sellers of their stash of US dollars?"

Paul Krugman opined on this subject yesterday in the New York Times (15 months after the Atlantic Monthly piece was published). Here is a piece of that article:

Some background: In the early years of this decade, China began running large trade surpluses and also began attracting substantial inflows of foreign capital. If China had had a floating exchange rate — like, say, Canada — this would have led to a rise in the value of its currency, which, in turn, would have slowed the growth of China’s exports.

But China chose instead to keep the value of the yuan in terms of the dollar more or less fixed. To do this, it had to buy up dollars as they came flooding in. As the years went by, those trade surpluses just kept growing — and so did China’s hoard of foreign assets......

Was there a deep strategy behind this vast accumulation of low-yielding assets? Probably not. China acquired its $2 trillion stash — turning the People’s Republic into the T-bills Republic — the same way Britain acquired its empire: in a fit of absence of mind.

And just the other day, it seems, China’s leaders woke up and realized that they had a problem.

And the Chinese DO have a problem. They have amassed a position in US dollars that is so large that it does not have ample liquidity for an orderly exit. That's just crazy...US Dollars are the most liquid asset on Earth! This isn't a tertiary market like pork bellies or frozen concentrated orange juice, Mortimer - it is the sovereign currency of the largest economy in the world.

I figured the Chinese knew what they were doing when they were buying all those dollars. I figured they had the best and brightest of the People's Republic in a quiet and stoic bureau somewhere in the governmental center of Beijing, and that those folks were planning for Chinese economic dominance on the grandest scale (like so many drummers at the Olympics Opening Ceremonies).

Maybe it was all an economic accident. And the global economic quandary for our times....