Chinese whispers frighten currency markets
By Chris Giles in London
Published: November 26 2004 20:16

The dollar fell to new lows on Friday on rumours that China might shift some of its currency reserves away from the greenback, highlighting the dollar-related jitters in financial markets.

The fragility in currency and bond markets has centred on fears that Asian central banks might dump US assets to avoid large losses as the dollar's value falls. The markets' nerves were highlighted by Friday’s investor reaction to a report, later retracted, that China's central bank was offloading US Treasury bonds.

The dollar dropped sharply after China Business News quoted Yu Yongding, a central bank committee member and a respected professor of economics, as saying China had cut its holdings of US government debt.

At one point on Friday, it hit $1.3329 against the euro before recovering to $1.3287.

On bond markets the yield on the benchmark 10-year US Treasury note was trading at 4.24 per cent, up from 4.2 per cent at Wednesday's close. It was the fifth week in a row that the yield on US Treasuries had risen.

Prof Yu said he had merely quoted to students in Shanghai data from the Federal Reserve supplied to him by a friend at a foreign investment bank, but his retraction did little to stem dollar falls.

The dollar started the week at $1.3059 and has declined in every trading day since as traders took fright at signs that Asian investors might become more reluctant to fund the US current account deficit.

On Friday, the deputy governor for monetary policy at Indonesia's central bank said Jakarta might reduce its reserves of dollar assets if the currency fell further. On Tuesday, the first deputy chairman of the Russian central bank said it might increase the proportion of its reserves held in euros.

Investors have taken the comments as a signal that the Chinese and Japanese central banks might also be reconsidering their asset holdings. If either began to shift into European or Asian assets, the dollar would plunge and interest rates on US government debt would rise sharply, damping US growth prospects.

For now, China and Japan have an incentive to retain US assets because doing so holds down their currencies and maintains exports. But many economists say the situation is not sustainable in the long term.