from Follow the Money

Has China lost interest in the euro?

May 7, 2008

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The blogosphere’s eyes and ears in the London foreign exchange market -- Macro man -- thinks so. China has, he thinks, been a net seller of euros over the past few weeks.   That is something of a change.  It has been a large net buyer for some time -- whether to hit its portfolio targets or in an effort to push the dollar share of its reserves down a bit.

If China’s foreign assets are rising at an annual rate of between $600 billion and $700 billion -- as Wang Tao, who just moved to UBS, believes -- just maintaining China’s existing portfolio targets might require selling something like $200b of dollars for euros a year. That amounts something like $1 billion of sales a business day, minus whatever euros come directly into the central bank from its intervention in the euro/ renminbi market. My calculations assume the central bank intervenes entirely the dollar/ renminbi market.

I find Macro man’s anecdotal evidence plausible because something clearly changed about a month ago.

Once the RMB reached 7, its appreciation against the dollar stopped cold.   Over the last month the RMB dollar looks a lot like a tightly managed peg.

That clearly reflects a policy decision inside China.   And it possible that China made a two-fold decision, first to slow (or stop) the appreciation against the dollar and second to do what it could to push the dollar up against the euro.    Stopping dollar sales is a rather obvious way to support the dollar if you are a big net seller.

The idea behind such a strategy would to be to get real appreciation through dollar appreciation rather than through renminbi appreciation against the dollar.   Or to get Europe off China’s back once China decided to slow its own appreciation against the dollar.  Or perhaps just to try to profit from a view that the euro has risen to the point where it is likely to fall.

I of course don’t whether China has actually scaled back its euro purchases. I would be curious what other think.  And I certainly don’t know if the decision to scale back euro purchases was tied to the decision to slow the RMB’s appreciation against the dollar -- that is pure speculation on my part.

p.s. A fall in Chinese purchases of euros/ rise in Chinese dollar holdings also might help explain the phenomenal recent increase in the Fed’s custodial accounts.

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