After the U.S. debt downgrade, everyone is wondering, what China will do next? With about $1.16 trillion in U.S. treasuries, the country holds about 8% of U.S. debt.Chinese economists and policy makers have argued that Beijing needs to diversify its foreign exchange reserves and move away from the USD, since the purchasing power of Chinese holdings of U.S. treasuries is expected to fall.
Deutsche Bank analyst Jun Ma believes that China will continue its path of gradual diversification and warns against a drastic sell-off of dollar reserves:
- A large selling of U.S. dollar assets by China will be noticed by global markets and could cause a panic selling of USD across the world. The resulting crash of the dollar would drive interest rates higher and hurt the U.S. economy. The end result? China would be hit hard because of falling OECD demand for Chinese goods. Jao also thinks this would single China out as being the country that added to global economic problems.
- Given that the renminbi is pegged to the dollar, a fall in the dollar would see a the renminbi depreciate as well. In that event China will feel even more political pressure than it already does from trading partners that have found their products less competitive against cheaper Chinese goods.
- If China were to attempt a sudden sell-off, the renminbi would be expected to appreciate against the dollar in the medium-term. Expectations for currency appreciation will drive hot money, like false foreign direct investment, into the country causing market instability.