The Trillion Dollar Question

China has accumulated over a trillion dollars in foreign exchange reserve holdings--the largest pile of reserves ever accumulated by any state--as it has emerged as the workshop to the world and earned a lot of foreign exchange in the process. It has recently made a decision to create an investment company to place these funds in things other than the likes of American or European sovereign debt. Previously, the misleadingly named State Administration of Foreign Exchange (SAFE) had sole responsibility for managing this pile. The big question that comes to mind is, will this action cause the dollar to weaken because demand for dollar-denominated instruments like Treasuries may fall? Well, it depends:

• Will the US allow China to make foreign investments in the US? As the Unocal and Global Crossing episodes demonstrated, the US has been reluctant in the past to cede ownership of "strategic" interests to China. If the US becomes more lenient, then Chinese monies parked in dollar assets may not fall as much;
• Deputy People's Bank of China governor Wu Xiaoling has said that "the government won't reduce its holdings of U.S. Treasuries and other forms of dollar-denominated debt" without elaborating;
• Even if China moves out of Treasuries into other dollar-denominated assets, interest rates may move up stateside as the largest buyer of American debt in recent years decreases the rate at which it's accumulating Treasuries.
  

At any rate, the dollar did not move much and actually strengthened a touch today--markets seem to discount a large Chinese exit from dollar-denominated instruments. Chalk this move up as a victory for Yu Yongding, a fellow keen on reforming China's economic boom in a sustainable direction. (I previously noted that China was already taking steps to level the playing field between foreign and local firms by unfying tax rates for both at 25%.) Early suggestions indicate that $200 billion of reserves will come into play. China is keen on investing in energy to meet its demands at home and in technology to enhance the value-added of its production. Look for the rest of the world to compete for Chinese investment.