The dilemma of holding US govt debt

Pang Li / China Daily

China has foreign currency reserves of more than $3.2 trillion, about 70 percent of which is believed to be in US dollar assets, especially in Treasury bills and bonds. Given the continuous increase in US government debts and downgrading of its credit rating by Standard & Poor's, the most obvious step for China would be to stop accumulating US Treasuries or start reducing its dollar assets.

But apart from the difficulty of switching from dollar assets to other currencies immediately, such a move could also cause a drastic drop in the dollar's value, which in turn could lead to a collapse of the international financial system. The value of China's dollar holdings will plummet, too. Besides, there are no other assets (gold, silver or other commodities) that could accommodate the huge influx of US Treasuries that China holds.

It has no desire to jeopardize the international financial system, but as a debtor nation the United States should also understand the needs and core interests of its largest creditor.

Under such circumstances, what exactly can China do?

China could start by reducing the use of dollar in international transactions and use its own currency, the yuan. In fact, it has already started doing so. The People's Bank of China, or the central bank, has signed currency exchange agreements with a number of countries, including Brazil, South Korea, Singapore, Malaysia, Indonesia, Belarus, Argentina and Iceland. And at a meeting in April 2011, the leaders of BRICS (Brazil, Russia, India, China and South Africa) agreed to promote the use of their own currencies to settle trade deals among them.

The setting up of offshore yuan markets is another step that will help internationalize the yuan. Such markets are already running in Hong Kong and Singapore, and more could be set up in countries and regions that have substantial trade with the Chinese mainland.

Offshore yuan centers will grow as more companies, both Chinese and foreign, trade in the yuan and their need to buy and sell their own currencies in exchange for the yuan becomes frequent. It is possible that even London, New York and Sydney, as well as more Asian cities could become offshore yuan centers.

But should the yuan become a reserve currency? Or more appropriately, is the yuan ready to become a reserve currency? The answer is a simple "no", because the Chinese currency still does not have many of the attributes of a reserve currency.

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