Give China a break. For now.

When China’s Premier Wen expressed concerns about a falling dollar, fears abound that it was the signal that China would be slowing down, if not stop the purchase of US assets.  Maybe valid but there is perhaps another reason that the fear might materialize (at least the slowing down would) and it’s not simply about the drop in the value of the greenback.  One just needs to look at the country’s reserves.  In a post by CFR’s Brad Setser, he explains:

[B]y my count, China’s total US holdings fell by $13 billion. Short-term claims fell by $11.3b, and long-term claims fell by $2b. China’s trade surplus was particularly low in February (largely for seasonal reasons), so less money was coming in. More importantly, one month does not a trend make.

Looking at the following graph might help put things into perspective:

china-feb

He notes that what’s worrisome would be if a rise in foreign reserves don’t translate to a rise in the purchases of US assets.

In a separate post, Setser looked at renminbi and pointed out that while they are not necessarily manipulating the currency as suggested by Tim Geithner a couple of months back, the currency still looks undervalued.

According to the (recently rebased) BIS real effective exchange rate index, the RMB has appreciated by over 10% since June 2008 — and by almost 18% since December 2007.

But make no mistake, China’s currency still looks undervalued. It is only a bit higher… than it was in 2001 or 2002, back when China was exporting a fraction of what it does now. In other words, the rise in the productivity of China’s economy hasn’t been mirrored by a rise in the external purchasing power of its currency. That is a big reason why China’s current account surplus remains large.

He went on to say that the currency is still effectively pegged into the dollar, yet this is not the time to be trying to change things just when the currency is appreciating in real terms.

If both are considered, then China doesn’t seem to be too much of a bad wolf as many people make it seem to be.  Sure, the currency is still undervalued and it needs further correction, let alone float against the dollar.  But when it is already rising and further rise could just weaken the global demand that mainly stems from and is highly dependent on the giant, it just might not be a good idea.  And that doesn’t help the fact that China’s reserves are already declining and their own stimulus still not completely kicking in.  Maybe when the crisis is over, that’s when the two should meet again.  For now, have a break.

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