China reconsiders reserve diversification

China, which recently unveiled plans to set up an agency under the aegis of the state that would manage the country’s surging forex reserves, is having second thoughts of sorts.  While the plan to more actively manage its reserves remains on coarse, the likelihood that this result in diversification has been somewhat diminished.  Estimates of the fraction of China’s reserves held in USD-denominated assets fall in the 70% range, which means that any decline in the USD could have multi-billion dollar ramifications for the value of China’s reserves.  And surely diversification would put tremendous downward pressure on the USD, which means China would likely experience the offsetting of gains from diversification with the relative decline in the value of its USD-denominated assets.  Forbes reports:

“Everyone knows that they should try to cut their US dollar assets. But, of course, if China wanted to make such a move, a big cut, our losses would be large as well. That would be very difficult to do.”

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