April 15,2009

Krugman: Dollar Depreciation May Cause China's US Asset Losses to Add Up

Paul Krugman, 2008 Nobel Prize winner in economics, says USD depreciation might lead to losses of about 20% to 30% for China’s US investments.
Mr. Krugman said in an interview in New York by 21st Century
Business Herald, a Chinese financial newspaper, that the largest risk for China’s investment in the US comes from dollar depreciation. "China is so deeply involved in the dollar trap that it is bound to see capital losses when diversifying its portfolio. This is China’s biggest concern."
The economist recently severely criticized the financial bailout measures of the Obama Administration, triggering wide controversy. News Weekly made his comments a cover story last week, addressing him as "Obama’s Nobel Headache."
"What China is doing now is what I’m constantly urging the Obama Administration to do."
Chinese Premier Wen Jiabao recently expressed his concern over the safety of China’s US investment. Mr. Krugman spoke of the risks. "China has recently bought a great many US government bonds and agency bonds. These are all with the government’s implicit guarantee, so China won’t see any capital losses, calculated in dollars."
According to Mr. Krugman, the largest risk lies in dollar depreciation against a basket of currencies (that China hopes to buy). China’s loss from its US investment, he says, won’t reach 80%, but could well be 20% to 30%.
"Some say the US will see malicious inflation, and I believe this would be the worst result, but I don’t think it’s is going to happen. To my mind, it has not been wise to accumulate so many dollar assets. This is far from a disastrous strategy, but it may be a waste of money." 
Although Krugman appreciates China’s economic stimulus plan, he doubts the "rebound" claimed by Chinese policy makers. "China has launched a very ambitious economic stimulus plan and its government is announcing various positive results, such as a credit boom, economic rebound. If all these are true, China is really doing very well. However, the rebound has comes too quickly and I’m quite doubtful, as I can hardly believe that bank lending and market emotion can change so fast."
"The economic decline is slowing, but in fact there’s no sign yet of a transition point," said Krugman. But he also admitted that "China is doing what I’m constantly urging the Obama Administration to do, which is to reverse the economic decline by large-scale stimulus."
Many Chinese investors and policy makers worry the Fed’s bailout measures, especially acquiring the US national debt by printing dollars, will lead to runaway inflation. However, Mr. Krugman disagrees. "I don’t think the US is facing great inflation. The Fed’s asset liability sheet is swelling quickly, but this is reversible. The larger risk is deflation, not inflation."


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