Yeah Right, But They'll Hold It Over Our Heads

Vested interests
by J. Christoph Amberger
People's Bank of China assistant governor Yi Gang told the World Economic Forum in Singapore that China will continue to hold the "bulk" of its record $1.2 trillion of foreign-exchange reserves in U.S. dollars.
One reason is because the greenback "is one of safest investment options."
Apparently, neither Yi Gang nor his compatriots at the People's Bank of China have been reading the daily reckoning and missives of other dollar bears who have been predicting the Chinese will be turning to euros any day now.
Instead, what the Chinese see is "safety, return and liquidity." Accordingly, adjustments to China's dollar holdings will be "incremental.''
This really shouldn't come as a surprise to anyone who has actually looked at China's highly successful policy of low-balling the yuan against the dollar. Even as Beijing allowed its currency to float within certain very limited parameters against the dollar, it began to buy up dollars.
In doing so, China has followed the time-honored strategy of the Bank of Japan: Decrease the relative value of the home currency (thereby making their competitive assets like labor and export goods cheaper) by pulling dollars out of circulation.
This strategy is likely to continue as long as the United States remains the largest single market for Chinese goods.
But it also creates a vested interest: Since a trillion and more of national wealth is being held in dollars, any substantial decline in the value of that asset would represent a severe loss in national wealth. In fact, any sudden switch out of this asset (in this case, the U.S. dollar) would result in an exponential loss of value of the remaining holdings.
There’s a fringe benefit of financial globalization: While fluctuations in exchange rates are laudable and enjoyable by speculators and traders, national self interest provides certain checks and balances in the overall equation to buffer the system against violent swings.