Forex Trading Strategies Blog

China’s central bank has stated that it will not reduce its dollar holdings for the present levels when it revamps its currency mix for its forex holdings. China’s forex reserves have now crossed $819 billion and it is widely believed that around 70% of these holdings are in US dollars. This high level of exposure to the US dollar can spell doom for China if the US dollar were to depreciate. On the other hand, if China were to reduce its dollar holdings it will have to sell that currency. This will lead to a drastic jump in the availability of the dollar in forex market and cause the currency to depreciate.

At the same time we are aware of the fact that China uses its massive dollar reserves to prop the US dollar by investing in US federal securities. China is also facing intense pressure from the G8 to allow its currency to float and appreciate to its true value. If China were to move to full convertibility in a jiffy, its need to hold dollar reserves will decline, which will have a major impact on the dollars value.

An appreciation in the Chinese Yuan combined with deprecation in the US Dollar, will reduce China’s export competitiveness to the US substantially and slow down its economy. We all know that China’s spectacular growth is key to global economic stability at this point of time and disturbing this will bode unfavourably for the global economy.

Thus, it is a catch 22 situation for China and it will have to be very careful in its forex management and take a very gradual approach towards full convertibility.

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