In March, when the US dollar reached an all-time low against major currencies worldwide, the central bank of China took three momentous decisions. It asked all commercial banks to reduce foreign debt. It also asked them to raise their cash reserves and deposits progressively each month. Further, it stipulated that the deposits and reserves of the commercial banks should have a dollar component exceeding that of the local currency, yuan.
With forex reserves of $1.9 trillion and a booming export-surplus economy, China could be merely protecting its exporters by buying the plunging dollar. If that was the only reason, there would have been no restrictions on foreign debt. Some analysts suggest the Chinese cut down on foreign debt prematurely, apprehending a post-Olympic slowdown in the economy. Others feel that the central bank’s accumulation of the dollar and cutting down foreign debt were not merely defensive measures.
This became evident in the months to follow as the dollar nosed its way up despite the crisis in the US banking and insurance sector. As the crisis deepened, the dollar spurted with speculators joining the fray, fuelling demand for the currency of a struggling behemoth.
Only two currencies kept pace with the dollar in the following months. While the Saudi riyal and the dollar moved up like Siamese twins, the yuan consistently overshadowed it. The yen, initially a laggard, made a late surge in October to catch up with the dollar.
Apart from China, large investors such as the Gulf Cooperation Council (GCC), the Saudi Arabian Monetary Agency (Sama), and the Saudi government have also accumulated dollars of late. As investors around the world pull out from the US in the aftermath of the housing crisis, their sovereign governments keep buying dollars to protect investor wealth and cushion exit losses.
Investors from many Gulf countries have been traditionally exporting oil and investing their surplus earnings in US bonds and assets so that there are no balance of payments problems.
It is reported that a few Saudi investor groups reacted with alacrity after the September crash, and have withdrawn up to 30% of their US investments of 1.5 trillion riyals in bonds and assets and pumped them back into the GCC market at home. Their exit losses have been comparatively low, thanks to the rising dollar. Several sovereign funds and other large investors are also withdrawing from the US and looking for alternative avenues in the Asian markets. What better opportunity if the dollar touches new highs when they sell out, and the rupee and the won keep crashing.
The Japanese joined the dollar buying party late and the yen spurted spontaneously with the news of yet another moneybag entering the stealth route to planned disinvestment.
It is expected that with a new US government around the corner, a buy-back arrangement will be worked out in the near future. However, the big question is the impact of such a buy-back and how it will be negotiated, if at all.
If not, how long will this party last? With the cash-flush Chinese and Saudis controlling the strings, who will pull the plug first? How far will the dollar rise and how sharply will it reverse? Will the Chinese let go of this unusual opportunity to make super profits? Since they started buying early when the dollar had bottomed out, they could make profits exceeding $100 billion at current prices. It could also be a premeditated move to help decouple their currency from the dollar and make the yuan stand on its own eventually, as a super currency.
Trillions of dollars of high-value assets will vanish with such an impending crash. How soon will it happen, if it does?
Sandip Sen is director of JMS Technologies. Comment at firstname.lastname@example.org