China has earned a reputation as a hypocritical investor over the past few years. It has repeatedly warned the US that quantitative easing was debasing the dollar, only to turn around and plough even more of its vast foreign wealth into dollar-denominated assets.

But perhaps those warnings weren’t so hollow after all. The latest data from the US Treasury suggests that China has in fact executed a major diversification away from the dollar.

The Wall Street Journal’s Tom Orlik has parsed the numbers to produce quite a startling revelation. The portion of China’s foreign exchange reserves invested in dollars appears to have fallen from 65 per cent at the end of June 2010 to 54 per cent a year later.

These figures are unavoidably rough. China does not publish the composition of its $3.2tn foreign exchange reserves and the US is one of the few countries to give a breakdown of which foreigners hold its assets.

However, Orlik is an authority on Chinese economic data and his estimates are as good as any out there. The point is not that China has been selling dollars; rather, it appears to have been accumulating them at a slower rate and instead investing much more in other currencies.

This evidence of diversification raises two intriguing points.

First, on a technical level, there is the possibility that Beijing has simply come up with a cleverer way of disguising its dollar investments. Analysts have wised up to its use of London and Hong Kong brokers for buying dollars, but perhaps it is now spreading out its deals much more widely, from Luxembourg to the Caribbean?

Second and more importantly, if it is indeed the case that Beijing has diversified away from the dollar, China’s influence over global bond markets would appear to be far less than has widely been assumed.

The long-standing fear in Washington has been that China might someday turn its back on the dollar, depriving the US debt market of its biggest foreign participant, crushing bond prices and driving up yields to the point that the economy suffers.

The hope in Europe has been just the opposite. The euro is the most likely investment target for China as it diversifies away from the dollar. And Brussels has been counting on more Chinese buying of euro assets to lower European yields, especially for the continent’s most indebted nations.

But have a look at what actually happened between 1 July 2010 and 30 June 2011 (the period covered by this week’s data which shows the big drop in Beijing’s dollar holdings). This table, based on publicly available Bloomberg charts, shows yields for 10-year government bonds in four important markets during that time:

10-year government bond yields

These numbers tell a powerful story. US debt handily outperformed that of shaky European nations and even outclassed the mighty Bund.

If China was indeed shifting from the dollar to the euro, bond markets couldn’t have cared less.

Related reading:
China is right to open up slowly
, Martin Wolf
China’s Treasury holdings in net fall
, FT
China’s reserves and the PBoC’s balance sheet
, Money Supply
Guest post: China, the world’s banker?

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