Rumours of China diversifying their US dollars

April 21st, 2009

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Back in January 2008 (15 months ago), we wrote in Why did the foreigners bail out cash-starved financial institutions?,

China?s trillions of US dollars reserve is a form of savings that will be used to acquire their future needs for resources to power their economy in the long term. Therefore, any threat to the long-term value of their savings will be a long-term threat to their economy.

The US is ‘printing’ their dollars into existence from thin air to fund their stimulus and bailouts at a time when the credit-worthiness of their financial system flounders in a deteriorating economy. Needless to say, the Chinese must have doubted that their hoard of US dollar reserves will function as a reliable store of value in the days to come. So what can they do? As we wrote twelve months ago, in What if the US fall into hyperinflation?, we wrote,

Since a collapsing US dollar means terrible unimaginable consequences, we expect countries like Europe, China, Middle East and Russia to be doing something quietly in the background. But it is not easy because if they do so in a hurry, there will be severe disruption in the financial markets, turning a US dollar rout into a self-fulfilling prophecy. What can these countries do? We see two major courses of actions:

  1. Slowly and quietly diversify away their US dollar reserves.  Obviously, none of these countries will be doing so while talking about it with their megaphones- the US dollar will crash straight away if they act so foolishly.

Today, we are hearing of rumours among mainstream economic commentators that the Chinese are buying up commodities (notably copper) as a means to diversify away from their US dollars. Not only that, there is a recent trend of the Chinese buying up stakes in resource companies (Rio Tinto, Oz Minerals) and spending money on resource investments all over the world (including Africa and South America).

Not only that, the Chinese are setting up currency swap agreements with their trading partners so that their yuan could be directly used for trade instead of using the US dollar as an intermediary. Some commentators are speculating that this is a Chinese scheme to set up their yuan as a world reserve currency.

In the months and years to come, the Chinese’s intention will become clearer. This will not be good for the US dollar. But if other countries are also inflating their currencies in order to fund their budget deficits, bailouts and stimulus, then the devaluation of the US dollar will not be apparent. Instead, it will show up as rising gold and commodity prices and the return of price inflation.

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