China still buying U.S. assets despite rhetoric

TOKYO (MarketWatch) -- U.S. capital-flow data on China's Treasury holdings show Beijing is still buying American, even as the two nations' dueling rhetoric over currency policy continued Friday.

"We simply want to see China's currency to float freely," U.S. Commerce Secretary Gary Locke reportedly said at an event in Shanghai hosted by the American Chamber of Commerce. See full story on Locke's comments.

For its part, China, as the largest holder of dollar-denominated reserves, has repeatedly taken aim at the U.S. dollar and voiced concerns this year over the world economy's reliance on the greenback as a reserve currency.

In March, People's Bank of China Gov. Zhou Xiaochuan proposed the creation a new international reserve currency in an essay published on the central bank's Web site, a call repeated several times since.

But the U.S. Treasury's international capital flow (TIC) report for May released Thursday showed China has not been backing up its expressed concerns with action.

"Despite media efforts to portray China's U.S. Treasury portfolio holdings as a looming crisis, the data does not bear this out," said Win Thin, currency strategist at Brown Brothers Harriman. "Bottom line: The big global reserve managers are not dumping U.S. dollar assets."

In May, China's net holdings of U.S. Treasury securities rose $38 billion, and the total rise in China's holdings across all U.S. securities in May was $36 billion -- the highest monthly increase since October 2008, Thin said.

All told, China's total U.S. dollar holdings have increased $229 billion since June 2008 to $1.43 trillion, he said, citing the TIC data. China's U.S. Treasury holdings have increased by $266.5 billion since then.

Locke's comments Friday had no currency market impact, as China tightly controls the yuan's trading range. Since it ended its currency's peg to the U.S. dollar in July 2005, China has permitted the yuan to trade in a narrow band -- now 0.5% -- on either side of its official parity rate, which it sets daily.

In stock market trading, the Shanghai Composite was down 0.4%, while Hong Kong's Hang Seng was up 1.1%.

Elsewhere in Asia, Japan's Nikkei 225 Average was up 0.4%, South Korea's Kospi added 0.3%, and Australia's S&P ASX 200 was down less than 0.1%.

Foreign reserves swell

For years, China has shrugged off similar calls from U.S. and European officials to allow the yuan to appreciate, as its relative weakness to other currencies gives Chinese exports a competitive edge in overseas markets.

The yuan gained about 6% against the dollar in the first half of 2008, before China abruptly halted the appreciation as the global credit crisis deepened and investors around the world sought the safety of U.S. assets, supporting the dollar.

Economists estimate around 65% of China's official holdings are in U.S. dollar assets, so the greenback's recent depreciation in line with investors' improving risk appetite has boosted the value of China's foreign-exchange reserves.

Already the largest in the world, Chinese foreign-exchange reserves swelled to $2.13 trillion at the end of June, as a record $178 billion were added to the reserves during the April to June period, the People's Bank of China said Wednesday. See full story on Chinese foreign reserves.

Reserves ballooned at a record pace, even as the nation's exports remained under pressure during the period because of weak global demand.

"We understand China's currency policy is aimed toward an eventual balance between inflows and outflows. But for now, inflows are dominant," said Patrick Bennett, strategist at Société Générale in Hong Kong.

The resultant higher foreign-exchange reserves "raise questions about China's intention to eventually diversify those holdings away from the U.S. dollar," he said in a note Friday.

Bennett said a modest yuan appreciation would work to slow inflows, as assets become more expensive, and also would be a damping influence on the trade surplus.

"We have expected that China will re-engage (yuan) appreciation in the second-half of this year," he said.

A separate set of data Thursday showed China's gross domestic product grew at a higher-than-expected 7.9% in the second quarter from the year-earlier period, as government-led stimulus measures and strong bank lending spurred domestic consumption and industrial activity. See Economic Report on China's GDP.

Lisa Twaronite reports for MarketWatch from Tokyo.

By Lisa Twaronite, MarketWatch