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How can China prepare for the possibility of "weaponizing" the US dollar?

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Editor’s Note: Yu Yongding is a member of the Chinese Academy of Social Sciences and a former member of the Monetary Policy Committee of the People’s Bank of China. This article reflects the views of the author and does not necessarily reflect the views of CGTN.

After the outbreak of the Russian-Ukrainian War in February, the United States and its allies frozen the Central Bank of Russia’s $ 300 billion foreign exchange reserves. Whatever the justification, the freeze seriously undermines the international credibility of the United States and shakes the foundations of the rules-based international financial system.

China has $ 3.3 trillion in foreign exchange reserves, including over $ 1 trillion in US Treasury bonds. The “weaponization” of foreign exchange reserves has forced China to reconsider its foreign exchange reserves and the security of foreign assets not only economically but also geopolitically.

China’s foreign exchange reserves are the largest in the world, nearly three times that of Japan, which is the second largest foreign exchange reserve in the world. China’s foreign exchange reserves far exceed the internationally recognized requirements for foreign exchange reserves.

Adjusting the balance of foreign assets and liabilities and the balance of payments to reduce holdings of foreign currency reserves

China began adjusting its balance of payments and external assets and liabilities (IIP) many years ago. There were two main purposes.

The first was to improve the structure of foreign assets and liabilities. With a net worth of $ 2 trillion, consisting of about $ 9 trillion in assets and $ 7 trillion in debt, China has consistently had an investment return deficit for decades. This vast cross-border resource misallocation is due to the majority of US Treasuries held by the Chinese government as reserves, but the profits are negligible.

The second was to minimize the potential loss of China’s foreign exchange reserves. In the post-Bretton Woods system, the major reserve currency, the US dollar, has been provided by the nation-state United States by running a current account deficit. As a result, US net external debt will be $ 18 trillion. No one knows if the US dollar will collapse or when it will. And inflation in the United States goes out of control. Therefore, China should reduce its foreign exchange reserve inventories to at least the adequacy level of internationally recognized reserves. Now, as a result of the Central Bank of Russia’s freeze on foreign exchange reserves, China needs to take this new aspect into account when redesigning policies to protect foreign assets in general, especially huge foreign exchange reserves.

Measures that may be considered for existing stocks of foreign exchange reserves include:

-Reduce US Treasury holdings by diversifying into other forms of foreign assets. This approach may not be as useful as previously thought, but it’s still worth a try.

-Increased equity investment in strategic resource-producing countries, including equity investment in oil companies in Central Asia and Arab countries.

-We are considering providing financing facilities to buy high quality Chinese concept stocks when Chinese investors plunge for geopolitical reasons.

-Strengthen the protection of foreign investors’ investment in China. The legal repatriation of investment income from foreign investors should be guaranteed.

-Provide necessary support for overseas financing activities of Chinese companies.

-Accelerate the construction of financial infrastructure, such as payments, clearings, and the construction of message systems that are not affected by the United States. Maximize China’s technological advantages in the field of digital technology to improve cross-border payment systems.

-Reduce holdings of US Treasury securities according to market rules without disrupting the market.

-Increase your gold holdings.

If there is not much we can do about existing foreign assets and debt inventories in the short term, there is much we can do to adjust the structure of China’s balance of payments that has led to the establishment of China’s current international investment position. I have. Here are some steps to consider for this:

-Stimulate domestic demand and promote imports by implementing expansive fiscal and monetary policies. Only when the domestic economy is booming will import demand increase significantly and a more balanced trade account will be achieved.

-Abolish the remaining export stimulus measures as soon as possible. For example, export tax refund policies should not be used to encourage exports.

-In order to increase the import of strategic commodities, it is necessary to expand the storage capacity of strategic commodities in China accordingly.

-Unless the unavoidable clause applies, China should do its best to import more US products in order to implement the US-China trade agreement, while suspending further purchases by the US Treasury.

-China must tolerate a trade deficit as long as it is the result of an economic boom and is inherently cyclical. That way, China can return the “IOU” to the United States for real resources.

-Comply with the floating exchange rate system and refrain from interfering with the foreign exchange market except in extreme cases.

-Maintain the capital regulations necessary to curb the inflow of hot money and prevent capital flight.

-Carefully increase equity investment abroad.

-Increase foreign direct investment in developing countries in order to fully demonstrate China’s superiority in manufacturing and infrastructure construction, but China will be aware of factors such as political instability and poor balance of payments in host countries. There is a need.

Can the internationalization of the renminbi play a role in the security of China’s foreign exchange reserves?

If we consider this question in the broad context of the world economic system, the answer must be yes. Internationalization of the renminbi is a worth pursuing goal. However, in the short term and in terms of immediate effect, the role of internationalization of the renminbi in protecting China’s foreign exchange reserves will be limited.

China’s foreign exchange reserves, even if they are entirely denominated in RMB, do not change substantially because the United States owes China its debt. If China is uncertain whether the United States can keep its debt repayment promises, China will have no choice but to gradually reduce its holdings of US Treasuries.

In the face of geopolitical and economic challenges, the only way China can completely eliminate concerns about the security of its foreign exchange reserves is to implement a “double cycle” strategy that keeps the economy open. However, it relies more on the domestic market or internal circulation to drive its growth. China wants the best, but unfortunately it needs to be prepared for the worst.

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