China caught in US money trap

China stuck in ‘dollar trap’

By Jamil Anderlini in Beijing

Published: May 24 2009 23:30 | Last updated: May 24 2009 23:30

China’s official foreign exchange manager is still buying record amounts of US government bonds, in spite of Beijing’s increasingly vocal fear of a dollar collapse, according to officials and analysts.

Senior Chinese officials, including Wen Jiabao, the premier, have repeatedly signalled concern that US policies could lead to a collapse in the dollar and global inflation.

But Chinese and western officials in Beijing said China was caught in a “dollar trap” and has little choice but to keep pouring the bulk of its growing reserves into the US Treasury, which remains the only market big enough and liquid enough to support its huge purchases.

In March alone, China’s direct holdings of US Treasury securities rose $23.7bn to reach a new record of $768bn, according to preliminary US data, allowing China to retain its title as the biggest creditor of the US government.

“Because of the sheer size of its reserves Safe [China’s State Administration of Foreign Exchange] will immediately disrupt any other market it tries to shift into in a big way and could also collapse the value of its existing reserves if it sold too many dollars,” said a western official, who spoke on condition of anonymity.

The composition of China’s reserves is a state secret but dollar assets are estimated to comprise as much as 70 per cent of the $1,953bn total and China owns nearly a quarter of the US debt held by foreigners, according to US Treasury data.

The collapse of Fannie Mae and Freddie Mac, the US mortgage financiers, last summer prompted Safe to adjust its strategy and start buying far more short-term US government securities, instead of longer-maturity bonds and notes.

This approach is widespread in the market because of expectations that the US will have to raise interest rates in the medium term to deal with rising inflation, as a result of all the money that it is printing.

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China is estimated to have currency reserves of two trillion dollars, but the bulk of it is tied up in US markets.

Caught in a "dollar trap", it has little choice but to buy more and more US government bonds to keep up the value of the dollar and hope a US recovery takes place - and quickly.

Al Jazeera's Owen Fay reports.