Off to the US. The reserve trap – What can the Chinese do?

27 Jul

Chinese Vice Premier Wang Qishan and State Councilor Dai Bingguo are off to Washington this week to meet primarily with Clinton and Geithner in a “Strategic and Economic Dialogue”.

In an op-ed in today’s Wall Street Journal Clinton and Geithner explain that “few global problems can be solved by the U.S. or China alone. And few can be solved without the U.S. and China together”.  The pair contend that addressing the global economic crisis and discussing sustained global growth will top their agenda, and outline the following points (amongst others):

FOR THE USA:
1. Rebuilding savings
2. Strengthening their financial system
3. Investing in energy, education and health care

FOR CHINA:
1. Continuing financial sector reform and development.
2. Spurring domestic demand growth and making the Chinese economy less reliant on exports.
3.  Raising personal incomes and strengthening the social safety

FOR BOTH NATIONS:
1. Avoid the temptation to close off their respective markets to trade and investment

There is a  Chinese saying: “When you are in a common boat, you need to cross the river peacefully together.” – so these talks  have the right idea.

Both economies are more tied than ever.  With its US$2 trillion in dollar denominated reserves the Chinese have been funding US consumption and growth for years.  Over that period talk between the two nations focused on what the US considers an artificially under valued Chinese remenbi.  With such staggering reserves I see the dialogue as likely to change, and expect the Chinese to start focusing US attention on its fiscal responsibility in a bid to ensure the value of those reserves.

The reserve trap? What can the Chinese do?
In my opinion the best thing the Chinese can do is to gradually and gently unwind a significant portion of its US reserves, and reinvest in ‘commodity’ producing assets, for example refiners and fuel sites,  and mines.  The fruits of these assets will ensure a long-term cash flow from ‘products’ the world cannot do without, and decouple the economy from such significant and direct influence of the greenback.  In addition, the Chinese will have greater control over the commodities required for its own domestic growth

Perhaps this is why the Chinese are so keen to invest in overseas mining, metal, and oil companies.

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