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Banker urges reserve diversification

(chinadaily.com.cn / Agencies)
Updated: 2006-06-28 11:59

In an interview with the Washington Post, Summers argued that he was not urging worldwide wholesale dumping of U.S. bills. He said central banks around the world must keep "large volumes" of their money in super-safe assets such as Treasury bills. And "any diversification" into riskier investments such as stocks "is not likely to be rapid, in ways that would affect" the U.S Treasury's ability to borrow at affordable interest rates, Summers was quoted as saying.

Analysts say China has been gradually diversifying away from holding predominantly dollar assets in its foreign exchange reserves, the world's largest, ever since or even before the central bank’s decision to scrap its decades-old RMB peg with the U.S. dollar, and the phase-in of a new exchange rate regime which is linked to a basket of foreign currencies in July 2005.

Last year, central bank chief Zhou Xiaochuan was cited in state media as urging domestic companies to use non-dollar currencies, such as euro and Japanese yen, in foreign trade and investment, to reflect more diverse trading and investment patterns.

"The central bank is not going to give you a hint in terms of direction of investment before they really do anything, so I don't read too much into this sort of general remarks," Qu Hongbin, economist with HSBC in Hong Kong, told Reuters.

Still, dealers took the comments as a reason to sell the dollar, whose long-term strength relies partly on central banks' willingness to stock it as their main reserve currency.

Some government economists have said China should convert some of its foreign exchange reserves, which hit $875.1 billion at the end of March, into gold to hedge against weakness in the dollar.

Summers's proposal is based on fundamental shifts in the global financial system that arose well after he left office -- in particular, an immense buildup in the reserves of foreign exchange held by developing countries' central banks. Those reserves have grown as the United States, with its burgeoning trade deficit, imports goods from abroad.

The dollars Americans spend on foreign products eventually end up in the hands of central banks overseas, and the central banks invest the proceeds largely in U.S. government debts. They do so in part because they want to protect themselves against financial crises of the sort that struck Thailand, Indonesia, South Korea, Russia, Brazil and Argentina a few years ago.

For a developing country, accumulating a big war chest of dollars can help discourage speculators from trying to drive down the value of its currency.