China remained the biggest foreign owner of US Treasuries, even as its holdings dropped by a net US$ 5.8 billion to US $ 889 billion, this according to Treasury Department data released yesterday in Washington. Japan cut its holdings in January by US$ 300 million to US$ 765.4 billion.

China has sought assurances from the United States over the safety of US government debt, especially at a time when the US budget deficit has increased to unprecedented levels, raising the spectre of runaway inflation. Because of this, Chinese officials have questioned the dollar’s role as a reserve currency.

Last week, Chinese Premier Wen Jiabao sought assurances that the US would protect the value of China’s dollar assets. At a press conference in Beijing marking the end of China’s annual parliamentary meetings, Wen said dollar volatility is a “big” concern and that he was “still worried” about China’s US currency assets.

Complicating matter is the fact that the low exchange of the yuan has made Chinese exports unbeatable, according to some analysts, in a world still reeling from a global crisis that cannot absorb all of them.

Indeed, about 130 US lawmakers called on US President Barack Obama to get tough with mainland over its currency practices. “The impact of China's currency manipulation on the US economy cannot be overstated. Maintaining its currency at a devalued exchange rate provides a subsidy to Chinese companies and unfairly disadvantages foreign competitors,” the legislators said in a letter.

Economist Maurizio d’Orlando told AsiaNews that the low level of the yuan is “something abnormal, excessive and beyond any conceivable limit.” Currently, the yuan is pegged against the US dollar at 6.833. However, based on purchasing power the yuan should appreciate by 33.43 per cent and be exchanged at around 5.121 against the US dollar (see Maurizio d’Orlando, “G8, toxic securities, US and Chinese addictions,” in AsiaNews, 7 July 2009). For d’Orlando, “China’s strategy is hegemonic; its purpose is one of national grandeur in the Far East.” But, “It is being achieved by destroying the manufacturing capacity of the rest of the world, enslaving entire domestic groups of people.”

By contrast, Yao Jian, spokesman for China’s Commerce Ministry, said, “If the exchange rate issue is politicised, then in coping with the global financial crisis this will be of no help in co-ordination between the parties involved”.

Nobel Prize-winning US economist Paul Krugman countered saying that “China's policy of keeping its currency, the renminbi, undervalued has become a significant drag on global economic recovery. Something must be done.”

Right now, inflation and possible financial bubbles are Beijing’s greatest concern. In the latest quarterly survey published in the China Securities Journal, 51 per cent of those questioned said they were dissatisfied with the current rate of inflation of 2.5 per cent. They said that they also expected inflation to continue rising next quarter. Consumer prices actually rose 2.7 per cent in the year to February, up from a 1.5 per cent pace in January.

Inflation appears to be the logical consequence of the government’s approach to the world crisis. In 2008, the authorities pumped 4 trillion yuan into the economy through loans to banks and companies, reaching 9.59 trillion last year (US$ 1.4 trillion). Experts note that much of the aid money was used to fuel real estate speculation and prop up bankrupt state-owned banks and companies.

Now, many fear that if the government stops giving out loans, China’s banks might collapse under the weight of bad debt; defaulting on their own loans and having customers default on theirs.

In a “worst-case scenario,” non-performing loans of local-government investment vehicles could climb to 2.4 trillion yuan (US$ 350 billion) by 2011, said Sjen Minggao, Citigroup’s Hong Kong-based chief economist for greater China.

If this should happen, the government would have to devise a massive financial bailout for the financial sector.