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Should We Worry About Chinese Dollar Holdings?

Posted By Don Boudreaux On January 17, 2006 @ 5:57 pm In Trade | Comments Disabled

This story [1] in today’s Washington Post reports that the Chinese now hold $819 billion in reserves of foreign currencies — presumably mostly in U.S. dollars.  And presumably we Americans are supposed to worry.

But I can’t figure out why we Americans (or anyone else, for that matter) should worry.

Take the extreme case: the Chinese continue to stockpile U.S. dollars without every spending them.  What a boon this scenario would be for Americans, for it would mean that the price we paid to China for the many valuable goods that we bought from producers in that country is green-ink-smeared paper.  We got electronics, textiles, and other things that make our lives better; in return, China got lots of miniature, monochrome portraits of dead American statesmen.

Of course, this extreme case doesn’t describe reality.  The Chinese are no fools; nor do they so intensely love American history that they’ll accumulate without end U.S. currency for the sake of possessing U.S. currency.

So they plan to spend this currency.

Does it matter when they spend it?  Not much.

Consider the opposite extreme from the one described above: the Chinese (and other foreigners with whom the Chinese deal) spend each dollar they earn the moment they earn it.  In this case, the Chinese accumulate no dollar reserves.  Each dollar Americans spend on imports from China returns immediately to the U.S. as demand for U.S. goods, services, or assets.  This scenario apparently is the punditry’s preferred one, for in it China holds no dollar reserves.

But how does this spend-their-dollars-immediately scenario differ from what is the likely, actual scenario?  In this most likely scenario, the Chinese accumulate lots of dollars and then spend them over time — sometimes spending them in big lumps (say, to buy several Boeing 777s), other times spending them more gradually, and always holding on to a few as a part of their portfolios or as part of a plan by the Chinese government to keep the dollar’s value higher against the yuan than it would otherwise be.

In both scenarios — one in which the Chinese spend their dollars immediately, the other in which the Chinese spend their dollars eventually — the dollars are spent and return to the U.S. as demand for U.S. goods, services, and assets.  The only difference is the timing.

I know that some people worry that the Chinese will suddenly dump their stash of U.S. dollars on the foreign-exchange market.  A sudden drop in the dollar’s value would indeed be unfortunate.  But the fall in the dollar’s value in this case would be from a height that the dollar reached only because the Chinese accumulated the stockpile of dollars in the first place — the same stockpile of dollars whose sudden dumping on foreign-exchange markets caused the value of the dollar to fall.

Also note: insofar as people with a serious stake in the matter — namely, currency speculators — really are worried about the Chinese suddenly dumping their dollars, these traders would start to short the dollar as soon as their concern became serious.  These actions on world currency markets will tend to smooth out the change in the dollar’s value.  That is, the value of the dollar will start to fall before the Chinese begin to dump their dollars — thus reducing, if not eliminating, the quickness of the dollar’s fall.

It’s possible, of course, that world currency traders and speculators are naive and never accurately anticipate what the Chinese will do with their dollars, but, if so, you’ll pardon me for paying no attention to pundits and politicians who fret about the size of Chinese dollar holdings.

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