Can China Dump the Dollar?

Kurt Brouwer November 15th, 2007

I recently read an interview in the Washington Post with Brad W. Setser, the Council on Foreign Relation’s currency expert. One of answers he gave was pretty revealing in terms of what China can and cannot do. First, here is a little background he gives on why China and other export-driven emerging economies do not want currency appreciation against the dollar:

Understanding the Falling Dollar (Washington Post/Council on Foreign Relations, November 12, 2007, Lee Hudson Teslik)

[Brad W. Setser]: ‘…the dollar is being supported, even now, by the resistance in many Asian economies–not just Asia, also many emerging economies around the world–to any strong increase in the value of their currencies against the value of the dollar. And by intervening to hold their currencies down, they are in effect holding the dollar up, not necessarily against the euro but against their own currencies. So I certainly think that has an impact…

[Lee Hudson Teslik]: ‘…There’s some concern that China will rapidly sell down its dollar reserves and that that will push down the dollar even further. How fast could they do that, feasibly, and is it a problem for the United States?

[Setser]: …But in my mind, so long as China resists more rapid appreciation of the renminbi [China's currency] versus the dollar, it’s rather difficult for China to diversify in any meaningful way against the dollar. If China really started to diversify away from the dollar, I think it’s a big enough player that it would put downward additional pressure on the dollar. So long as China itself pegs to the dollar or manages its currency primarily against the dollar–technically China has a crawling peg, and it’s clear from a range of economic analysis that it’s crawling mostly against the dollar, not against a true currency basket–then if it puts pressure against the dollar, it’s also putting pressure against its own currency…

…And given current economic conditions in China, I’m not sure that’s something China wants to do. So that’s a meaningful constraint on China’s ability to change its portfolio. But I would note that since maintaining the current value of the renminbi versus the dollar requires China buy a lot of dollars, not just hold onto its existing stock of dollars, means that keeping the dollar from falling and keeping the value of China’s current dollar holdings constant, means that China has to continually increase its exposure…’

We have known for a long time that those countries that export heavily to the U.S. do not want to see lots of appreciation in their own currencies because that would make their products less competitive here. Among these exporters, China is the largest.

Setser’s point is that China is already struggling to prevent appreciation of its currency against the dollar. If China dumps dollars, then the dollar might fall and its own currency would probably appreciate versus the dollar, thus exacerbating a problem it already faces. In addition, China does not want to do anything that would help push the U.S. into a recession because when the U.S. economy slows, the rest of the world does too.

In conclusion, it seems unlikely that China would dump dollars. In addition, China will probably have to keep increasing its dollar reserves for some time to come.

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  10. modulagroon 20 Jul 2008 at 11:45 am
  11. johnon 06 Mar 2009 at 8:40 pm

    the falling dollar keeps falling and falling. The world is in a scary place. I am not sure what to do.

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