China rules out 'nuclear option' on U.S. debt

(News Today) - China has delivered a qualified vote of confidence in the dollar and US financial markets, ruling out the "nuclear option" of dumping its huge holdings of US government debt accumulated over the last decade.

But the State Administration of Foreign Exchange, which administers China's $2450bn in reserves, the largest in the world, also called on Washington and other governments to pursue "responsible" economic policies.

The statement on Wednesday, one of a series that Safe has issued in recent days in an apparent effort to address criticism about its lack of transparency, also played down the chances of China making major further investments in gold.

Safe's comments coincided with the news that China had made record purchases of Japanese government bonds in the first four months of the year, helping push the yen to an eight-month high against the dollar.

Analysts said it was too early to tell whether China's move into JGBs was the start of a trend, but Greg Gibbs, FX strategist at RBS, said unlike in the US, Tokyo would not welcome foreign central banks routinely accumulating yen assets.

With such inflows not required to help stabilise its currency given the country's current account surplus, yen appreciation could hurt the country's exporters.

"If this persists it may generate tensions between Japan and China. It would seem a little ridiculous for Japan to allow the yen to be pressed upwards by inflows from China, when Japan is not able to counter with renminbi asset purchases," said Mr Gibbs.

About two-thirds of Safe's funds are believed to be in dollar assets, giving China a huge exposure to the US economy but also raising fears that the holdings could be used to pressure Washington.

Given the US government's huge funding needs, some analysts worry that China's stated objective of diversifying its reserves could also lead to higher US interest rates if it buys fewer Treasuries.

However, Safe said that the "nuclear" option of selling huge volumes of US assets was "completely unnecessary". Given its security, liquidity and low transaction costs, the US Treasury market was "a very important market for China". It added: "Any increase or decrease in our holdings of US Treasuries is a normal investment operation."

The statement said that while Safe had worried that the dollar could drop sharply because of heavy US borrowing, the problems in other countries -- notably in the euro area -- had made this a less pressing problem.

However, it added: "China has been calling for the US to genuinely take measures to protect investors' interests and confidence as a responsible large nation."

Since the start of the financial crisis, Chinese leaders have publicly expressed concerns about the weakening dollar and rising US debt levels, calling on the US to pursue sound fiscal and monetary policies.

Although US officials say that in recent months China has not been privately critical of its economic policies, scepticism about the dollar remains widespread in China.

"Even with the situation in Europe, the bigger problem is still the US and its long-term debt position," said Yu Yongding, an economist at the Chinese Academy of Social Sciences, in a recent interview.

Safe said the gold market was too thin and volatile and even a big purchase would not help to diversify its holdings a great deal. "There are some limits to investing in gold and it cannot become a main channel for investing our foreign exchange reserves," it said.

Safe has been criticised at home for some of its investments, including the large reported stakes it has taken in US equities before the financial crisis. The body said: "Safe will never be a speculator. It mainly seeks to protect the safety of China's foreign exchange reserves and to ensure a stable investment return."

Source : CNN

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