Interest Rate Roundup

Thursday, November 09, 2006

China and reserve musings

The dollar is getting beat up a bit, and gold is jumping more than $18 today. Why? People's Bank of China Governor Zhou Xiaochuan made some comments about diversifying that country's gigantic pool of foreign exchange reserves. China is sucking in gigantic amounts of money from all over the world by running massive trade surpluses with its trading partners. Reserves just topped the $1 TRILLION market, in fact, the most of any country ever in world history. That's 21% of world reserve assets; Japan is second at about 18.4%, according to Bloomberg.

Estimates of how much of China's reserves are in dollars and dollar-based assets are all over the map. One former advsier to the central bank's monetary policy committee said it was "more than half." A recent estimate from Roubini Global Economicss puts the dollar share at 70%. A gigantic portion of those reserves are in U.S. bonds -- Treasuries, spread product, you name it.

And that goes back to the point in my last post: The global surge in money supply and reserves available for investment appears to be distorting the interest rate markets. So much money is looking for a home, and chasing yield, that it's suppressing overall interest rates. It's only a theory, but it seems to fit from where I sit.

I should add that IF China ever gets around to unloading some of its U.S. bonds, the impact on our interest rates would be severe. Who knows when that will happen. But it's unlikely this situation (we buy stuff from China, ship China our dollars, which they invest in our bonds) will last forever.


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