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EduPristine>Blog>Chinese Dollar Reserve Risk Management

Chinese Dollar Reserve Risk Management

March 26, 2010

World financial sphere is concerned with the way China is using trade, currency Rules to boost its exports. Seeking to maintain its export dominance, China is engaged in a two-pronged effort:
(a) fighting protectionism among its trade partners and
(b) holding down the value of its currency.

This has already drawn world’s ire on China. Washington wants Beijing to abandon a currency peg against the dollar that U.S. lawmakers believe gives Chinese exports an unfair advantage in world trade and so steals American jobs.

But the Chinese are vigorously defending their economic policies. Premier Wen Jiabao criticized international pressure on China to let the currency appreciate, calling it “finger pointing.” He said that the renminbi, China’s currency, would be kept “basically stable”.

Additionally, China has already begun the process of diversifying its foreign exchange reserve assets, pushing settlement in yuan with its trading partners, and pressuring the US government to be responsible in its fiscal policy.

Although many countries, including Russia and Brazil, are willing to settle bilateral trade with China in local currencies instead of USD, China is most interested in RMB settlement in trade with its Southeast Asian neighbors. Border trade with countries such as Vietnam is being very aggressively pursued. China is promoting the establishment of a free trade zone, which will develop into a currency zone.

To maximize its advantage, Beijing is exploiting a fundamental difference between two major international bodies: the World Trade Organization, which wields strict, enforceable penalties for countries that impede trade, and the International Monetary Fund, which acts as a watchman for global economic policy but has no power over countries like China that do not borrow money from it.

The Chinese are buying dollars and other foreign currencies worth several hundred billion dollars a year by selling more of its own currency, in order to depresses its value.

An undervalued currency keeps a country’s exports inexpensive in foreign markets while making imports expensive. That makes a trade surplus more likely, reducing unemployment for that country while increasing unemployment in its trading partners.

China strategy can be attributed to the fear that their banks will be exposed to greater credit risk in event of the yuan’s appreciation.

China apprehends that its credit risk would increase due to the revaluation which would raise export costs and dampen competitiveness in the international market, resulting in the failure of enterprises.

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