This is a moot question and there is no firm answer to this at this point of time. China has gradually started reducing its exposure to the US dollar and it may just be paring its risk, given the uncertainty of the US economic conditions or it may be strategically embattled in dethroning the US dollar as the world reserve currency.
China reduced its US Treasuries holdings substantially in June this year in the face of falling returns on the instruments. Further, China seems to be investing in government paper of Europe, Korea and Japan. As per a US government report, China reduced its holding of long term US Treasuries by $ 21.2 billion in June to $ 839.7 billion. China reportedly has purchased over $ 20 billion more of Japanese debt than it has sold. China has also reportedly doubled its debt exposure in Korea. China’s move to increase its exposure in Asia appears to be aimed towards creating a more diversified investment portfolio given the uncertainty in both the US and Euro zone economies.
China’s move coincides with its other strategic move to remove the peg between the Yuan and the dollar in June this year. The Chinese currency has appreciated by 0.5% since then. At the same time, the Chinese central bank has allowed foreign central banks to increase their investments in the Chinese inter bond market. The three actions when read together, suggest that China is trying to offer its currency as an alternative to the US dollar as an investment option and a reserve currency. However, the Chinese move of selling US Treasuries may simply be its strategy to book profits due to an appreciation in the investments, with the US buying its own treasuries to keep interest rates low.
With China holding the largest dollar reserves, any move by the nation to dilute its holdings could have an impact on the demand for the dollar and its exchange rate. This is a double edged sword for China as a loss in the dollar’s value also results in the loss in the dollar holdings for China. As China has massive reserves of dollars, it cannot afford to let the dollar fall drastically or else it will experience erosion in the value of its dollar holdings.
While one can speculate on what China will do with its dollar holdings and how that can impact the long term value of the dollar, as of now, the dollar continues to be the dominant reserve currency as well the choice as the hedge currency. Any weakness in economic data is likely to make investors take cover in the safety of the US dollar and such a move will lead the dollar to appreciate. With the latest US housing data suggesting that the US economy is on a weak wicket, the US dollar immediately moved up and demonstrated its strength as the currency of choice in times of economic uncertainty. Existing home sales in the US fell 27.7% in July, suggesting the US economy was losing steam again. This led investors pulling out of risky securities including stock markets across the globe and running to the safe haven of the US dollar, which displayed the tendency to appreciate.
Thus, in the immediate future the US dollar continues to be king, with its long term trend depending upon a variety of factors like the performance of the US economy and moves by nations like China in relation to their massive dollar holdings amongst other factors.