FOREX TRADING

According to a Treasury Department report released Tuesday China sold a record amount of US debt in December. The Treasury said that China sold $34bln of US Treasuries in December. China owns $755.5bln of US government debt. After the December sale of US Treasuries China slipped to number two behind Japan as the largest holder of US treasuries. Japan’s holdings of US debt rose 1.5% in December to $768.8bln. Japan is now the largest US creditor. China’s sale of US debt reflects concern about the USD. The US announced a record 1trln budget deficit for 2010 and deficits in the US are expected to remain in excess of $1trln for a number of years to come Chinese officials are becoming wary of holding US long-term debt as a weaker USD would reduce the value of Chinas US debt. China’s PBOC Deputy Governor Min said that USD will decline because of concern about rising US debt. China’s December sales of US Treasuries may also reflect the fact that China and US are in disputes over the value of the Yuan, trade imbalances and human rights violations in China.

US officials want China to allow the Yuan to appreciate and correct what is perceived as undervaluation of the Yuan to help reduce the global trade imbalances. There is speculation that China may be preparing to allow a 5% revaluation of the Yuan to try and curb China’s rapid growth and avoid the creation of a possible asset bubble in the Chinese economy. Because China’s currency is pegged the Chinese central bank has limited tools to curb money supply growth and economic activity save for tightening of credit conditions. Yuan revaluation could be an additional monetary policy tool for China. If China allows the Yuan to gradually appreciate China would have less of a need to buy US Treasuries to intervene to maintain the Yuan peg. China’s selling of US Treasuries may also reflect increased tensions between US and China over trade and human rights issues. Chinese officials are not happy with President Obama’s plan to meet with Dalai Lama and a number of trade issues are brewing which include chickens, tires, and steel and auto exports.

Last September the US imposed 35% important tariff on China’s export of tires. More tariffs may be coming with trade disputes between US and China likely to escalate throughout the year. The trade disputes will increase the risk of protectionism. Rising protectionism and China’s reluctance to buy US treasuries could present a significant long-term risk to the USD. Currently Forex market focus is on improving US economic outlook and concern about sovereign debt risk in Europe. These factors overshadow concern about rising US debt, servicing of the debt and trade friction. So far China’s shift out of the U.S. Treasuries and US reserves has been gradual and because of the Yuan USD peg China will need to continue to buy the USD. This means that the USD is not at an imminent risk despite China’s record sale of US Treasuries in December. Whether China continues selling U.S. Treasuries will depend on US efforts to reduce its deficit and China’s decision on how much Yuan appreciation it will tolerate. President Obama plans to create a debt reduction commission. Tuesday the Fed’s Hoenig said that the US must fix its growing debt problem or risk a new financial crisis. China’s record sale of US Treasuries in December reflects concern about the risk of new US financial crisis.

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