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Foreign purchases of U.S. treasury bonds in recent years have helped keep American interest rates low. China has been one of the biggest buyers. Now China has much of its foreign exchange in U.S. treasury bonds, part of a total reserve worth over a trillion dollars. But China has recently announced the creation of a government investment firm to diversify its holdings.
As NPR's Anthony Kuhn reports from Beijing, investors are warily eyeing the results.
ANTHONY KUHN: China has two objectives as it rethinks the use of its foreign exchange reserves. It wants to get better returns on its investments than U.S. treasury bonds offer, but it's also got to make sure that moving this money doesn't cause turmoil in global markets. Earlier this month, China's premier, Wen Jiabao, tried to allay fears about the new investment company.
Premier WEN JIABAO (China): (Foreign language spoken)
KUHN: It's a fact that most of China's foreign exchange reserves are in dollar-denominated assets, he said. China's purchase of these assets benefits both sides. Our establishment of a foreign exchange investment company will not have any adverse effect on dollar-denominated assets.
China is not going to move a trillion bucks all at once. The new investment company is expected to get around $200 billion to work with at first, admittedly no small change. As Stephen Green, senior economist with Standard Chartered Bank in Shanghai, notes, even if China takes some money out of U.S. treasury bonds, it's still going to be holding on to a lot of them. So it has to be careful not to shoot itself in the foot.
Mr. STEPHEN GREEN (Senior Economist, Standard Chartered Bank): If China itself causes the dollar to collapse, then the value of its reserves will also collapse. So China has no interest in that. And of course if it was to cause a perilous freefall of the dollar, then of course there will be political issues as well.
KUHN: China has remained quiet about exactly what the new company will invest in. Green says different ministries are promoting different investment priorities, from foreign stocks and companies to oil and other resources. Finance Minister Jin Renqing recently outlined the new firm's goals.
Mr. JIN RENQING (Finance Minister, China): (Foreign language spoken)
KUHN: We want to manage the investment of our foreign exchange reserves more profitably and efficiently, he said, but with financial safety as a pre-condition.
Economists say China's foreign exchange reserves are growing by $20 billion a month, and this is causing problems. Dollars are pouring in from China's trade surplus, as well as from foreign direct investment and from speculators betting that China's currency will appreciate. All this money threatens to fuel inflation. Pang Xing Yuen(ph) is an economist with the Chinese Academy of Social Sciences. He says that China has to create an outflow of dollars to offset the big inflows. He says the new company will do that, and he adds that U.S. fears about the reforms are exaggerated.
Mr. PANG XING YUEN (Economist, Chinese Academy of Social Sciences): (Through translator) China's holdings of U.S. treasury bonds are less than people think. Besides, this readjustment of foreign exchange holdings began several years ago and its impact on U.S. financial market so far has been very small.
KUHN: U.S. financial policy makers seem unfazed by China's plans for its reserves. Treasury Secretary Henry Paulson recently commented that all of China's U.S. treasury bond holdings represent less than one day's volume of trading on global bond markets.
Anthony Kuhn, NPR News, Beijing.
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