The two most influential people in the world economy in 2005 will be Chinese central bank governor Zhou Xiaochuan and the manager of a small Dutch pension fund. Between them, these two characters hold in their hands the fate of the US dollar and whether it has a graceful landing or a crash landing.

Governor Zhou is sitting on foreign exchange reserves of $515bn and has $180bn of that invested in US treasuries, making China the second largest foreign holder after Japan.

In late November, rumours that China had dumped bonds to avoid losses from a falling dollar sent treasury prices down and caused panic that China could begin selling indiscriminately. While the Japanese are still engaged in the classic Asian central bank strategy of selling their own currency and buying dollars in a bid to keep their exchange rate competitive, the Chinese have a different rationale. They are under great pressure to revalue the renminbi.

By market criteria, the renminbi could be revalued upwards by 10%–20%. More likely, in a few months’ time China will allow the renminbi to float in a 5% band but, before it does so, Mr Zhou may decide to make further sales of US treasuries. If not, China’s holdings will be worth at least 5% less in renminbi terms plus however much the dollar continues to fall.

To a Chinese central bank governor who has other plans for his country’s foreign exchange reserves ($45bn went to shore up the state-owned banks Bank of China and China Construction Bank, which are struggling with problem loans), this must seem like a bad deal and one to be avoided.

Market watchers are anxious. Tony Norfield, global head of foreign exchange strategy at ABN Amro, says: “We expect Asian central banks to buy fewer treasuries in 2005. This will be serious enough; if they start selling, it could lead to a market panic.” He expects a 5% revaluation of the renminbi in mid-2005 and a similar adjustment to the Malaysian ringgit peg by the year end.

Mr Zhou’s sentiments are not the only worry for dollar watchers. There are also the actions of small Dutch pension fund managers. The large ones have already hedged their dollar assets to match their liabilities because they must conform to Financieel Toetingskader – new pension fund legislation that comes into force in January 2006. But the small ones have yet to decide on a strategy: sell dollar assets or hedge against falls in their value relative to the euro in order to hold less reserves. By one estimate, small Dutch pension funds have E40bn-worth of dollar assets to hedge, which could put the dollar in further trouble.

For Americans to have their currency trounced by the double impact of Zhou Xiaochuan and Financieel Toetingskader must seem confusing. But it could lead to some good copy on the Dubya website as the US president tries to get his tongue round those foreign names.

PLEASE ENTER YOUR DETAILS TO WATCH THIS VIDEO

All fields are mandatory

The Banker is a service from the Financial Times. The Financial Times Ltd takes your privacy seriously.

Choose how you want us to contact you.

Invites and Offers from The Banker

Receive exclusive personalised event invitations, carefully curated offers and promotions from The Banker



For more information about how we use your data, please refer to our privacy and cookie policies.

Terms and conditions

Join our community

The Banker on Twitter