China Orders Retreat from Risky Assets

Source:

". . .this will have the paradoxical result of boosting the dollar"

China has ordered managers of its vast currency reserves to withdraw from risky dollar assets and retreat to core debt guaranteed by the U.S. government, a clear sign that Beijing is battening down the hatches for fresh trouble on global markets.

A Communist Party directive leaked to the Chinese-language edition of the Asia Times said dollar reserves should be limited to U.S. Treasuries or agency mortgage debt, such as Freddie Mac that enjoys Washington's implicit backing.

BNP Paribas said the move has major implications for global risk assets. "The message from Beijing is that we don't like this environment," said Hans Redeker, the bank's currency chief.

The directive covers both the State Administration of Foreign Exchange (SAFE) and China's state-controlled commercial banks. Together they have an estimated $3 trillion of foreign holdings.

The exact breakdown of China's holdings are a state secret but it is understood that SAFE bought large amounts of corporate debt as well as municipal and state bonds during the boom years of 2006 and 2007. Any move to liquidate holding of California debt at this crucial juncture could have serious implications.

The exact motives for China's shift of strategy are unclear. Analysts say the authorities may fear that the end of quantitative easing by the U.S. Federal Reserve could cause risk spreads to widen sharply, triggering heavy losses. The shift in policy appears unrelated to the U.S. spat with China over Taiwan.

The move by Beijing comes at a time when China's current account surplus is falling. This reduces reserve growth, reducing the supply of global liquidity.

Mr. Redeker said this will have the paradoxical result of boosting the dollar. Flight from risk can lead to an automatic rise as hedge funds, banks, and investors across the world cut back leverage on dollar balance sheets.

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