Foreign exchange reserves: why China fears the next American president

The outcome of the American presidential election could well seal the economic fate of China, whose dollar reserves are the subject of great concern. With an economy in need of momentum, the Middle Kingdom fears the sanctions that the future POTUS could impose. Beijing knows that the measures, if they are taken, risk being heavy. To face this possible tsunami, economists are calling on China to de-dollarize part of its foreign exchange reserves, fearing a devastating American economic response.

Imminent risks: why China should reduce its dollar reserves

China, which is witnessing an unprecedented economic crisis and which holds the largest foreign exchange reserve in the world with some 3.3 trillion dollarsfaces colossal challenges. Zhang Ming, deputy director of the Institute of Finance and Banking of the Chinese Academy of Social Sciences, sound the alarm. With the US elections in its sights, Beijing fears that the next president of the United States is intractable and imposes sanctions. Moreover, the latter is among the 3 obstacles that threaten the recovery of the Chinese economy.

The spectrum ofa “trapped dollarization” looms, where dependence on the greenback would put the Chinese economy at risk in the event of unilateral punitive measures.

Zhang suggests several ways to limit the risks:

• Diversification of assets: moving from centralized management towards more diversified investments;
• Transfer to companies and individuals: decentralize control of assets;
• Creation of a sovereign pension fund: invest reserves in a more stable framework and less exposed to fluctuations.

With 55% of these reserves still denominated in dollars in 2019, China knows that any retaliatory measure will violently impact the stability of its reserves. The precedents are full of meaning: in 2022, The United States and the European Union froze 300 billion in Russian assets in response to the invasion of Ukraine.

For China, whose relations with Russia – with India, it has absorbed 78% of Russian oil – worry Washington, these examples remind us that a response is entirely possible, and could undermine the solidity of its dollar assets.

Economic sanctions: a danger for Chinese stability

If the word “sanctions” makes Chinese economists shudder, it is because recent history clearly shows the possible damage. US Treasury Secretary Janet Yellen said in April that Washington would not hesitate to reuse its “sanction tools” if Beijing were too enterprising towards Taiwanpushing towards inevitable war.

And Beijing has not forgottenisolation imposed on Russiawhich was excluded from SWIFT, the international payments system, and whose foreign currency reserves were frozen.

Russian precedents demonstrate that such sanctions are possible against China, especially if a more aggressive U.S. president takes the reins. The emergence of an American policy of monetary isolation is worrying, but China is preparing to react.

After all, its economy, a global engine, cannot afford to bet everything on the dollar.

For Beijing, the solution seems to be an increasingly pressing de-dollarizationas evidenced by the gradual sale of its American Treasury bonds, which went from more than 1,300 billion dollars to less than 800 billion in three years. As for Japan, an ally of the United States, it is today the first holder of these titles, a situation which exposes Beijing to American political whims.

In Europe, the tone is set: Brussels has already applied a massive surcharge to Chinese electric vehicles. Faced with such a context, the Middle Kingdom has work to do to revitalize its economy.