Currency dispute with US escalates as China divests bonds (Feature)

By Andreas Landwehr Mar 20, 2010, 4:08 GMT

Beijing - Tensions rose this week between China and the United States amid mutual accusations of currency manipulation as figures showed China was reducing its holdings in US Treasury bonds.

China sold 5.8 billion dollars of US bonds in January, the US Treasury Department said Monday. This third consecutive month of divestment brought Chinese holdings in US bonds down to 889.6 billion dollars, the lowest level in eight months.

Every move that China makes on the bond market is carefully watched by the Treasury Department, wary of any slackening in demand for US bonds that could further weaken the dollar.

But it does not seem that China intends to part with its US treasury bond holdings entirely. Experts hint at a mere re-distribution as China continues to purchase bonds through financial institutions in Hong Kong or London.

The director of China's State Administration of Foreign Exchange, Yi Gang, told news agency Xinhua earlier this week that China's sale of bonds was driven by market considerations, not by political motivations.

The US bond market is important for his country, Yi said, as China hold the world's largest US dollar reserves, around 2.4 billion dollars.

But comments by Prime Minister Wen Jiabao on Sunday left little doubt that China's trust in US economic policies and the stability of the dollar is not particularly strong.

'Every fluctuation in the value of the US currency is a big concern for us,' Wen said at the end of this year's Peoples' Congress session, which ran from March 5 to 14 in Beijing.

Asked whether he believed that US bonds were a safe investment, he said 'one year ago I said I was worried and today I also say I am worried.'

The value of the bonds was based on the United States' 'national credibility,' he said. 'I hope the US will take concrete action to ensure the security of those assets to reassure its foreign investors,' Wen added.

The prime minister even accused the US of keeping the dollar deliberately weak in order to promote the country's exports.

His comment was seen by observers as a rebuttal of similar accusations made against China over recent years by the US and the European Union.

These mutual recriminations are increasing tensions between the world's largest economy - the US - and the emerging economic giant China, which is set to unseat Japan this year as the world's second-largest economy.

China has so far refused to adjust the value of the yuan, which has practically been pegged to the US dollar since July 2008.

Allowing the yuan to appreciate, as the US has called for, would increase the overseas price of China's exports, hurting their competitiveness. Chinese exports already declined by 16 per cent last year.

US experts insist that the yuan is under-valued by between 20 and 30 per cent. A rise in the value of the yuan would make US products more competitive against Chinese ones.

Chinese monetary policy is compounding the world's already severe economic problems, economist Paul Krugman wrote recently in the New York Times. 'It's time to take a stand,' he said.

The US Treasury Department is scheduled to decide by April 15 whether China is indeed 'manipulating' its currency. If China is deemed to be maintaining the yuan at artificially low levels, and if it does not take any clear steps towards unpegging its currency from the US dollar in the next month, the US is likely to impose trade sanctions, the Standard Chartered Bank said in a recent report.

How China responds will set the tone for global trade and foreign exchange markets for the rest of 2010, the paper said.