China's Effect on Dollar Reflects Growing Influence
A Chinese lawmaker on Wednesday said his country would diversify foreign currency reserves away from a falling U.S. dollar, and his comments helped drive the value of the dollar to a record low against the euro.

The official has no say over Chinese monetary policy, but the reaction was a reminder of China's growing influence in a global economy it once shunned.

The official is vice chairman of China's parliament — not an especially powerful position. But his words helped move the markets.

Growing U.S. Dollar Reserves

In the 1990s, if a Chinese official had talked that way, "probably such comments wouldn't have been noticed in the international financial press," says Thomas Rawski, a specialist on the Chinese economy at the University of Pittsburgh.

He says the reason for China's growing influence is simple: China has far more U.S. dollar reserves today than it did 10 years ago.

The country has about $1.5 trillion worth of foreign currency.

"Their foreign exchange reserves of about 1.5 trillion are bigger than the GDP of all but a handful of countries in the world," says Nick Lardy, a China specialist with the Peterson Institute for International Economics in Washington, D.C.

If China were to dump dollars, it would hurt the U.S. currency.

But because China is now so linked to the American and global economies, Lardy says, it would pay a price for doing so.

A Profound Transformation

China depends on American consumers to buy its exports.

"It has a very strong interest in high economic growth in the United States because that's what generates our demand for imported goods, which is what generates the demand for China's exports," Lardy says. "I think they're also interested in a relatively stable international financial system."

It wasn't always that way. When Lardy visited China in 1978, it was essentially a closed, communist state.

"They were almost completely isolated from the global economy," he says. "Their trade was miniscule. They did not borrow any money abroad. China not only didn't have any economic interaction with the rest of the world, [but] during the Cultural Revolution, they withdrew all of their ambassadors from every country except Egypt."

But these days, Lardy says, China has undergone a profound transformation.

"China, for the last couple of years, has been the third-largest trading economy on the globe," he says. "They have the world's largest foreign exchange reserves; they are participating in all of the international financial institutions, which they were absent from."

And that integration has benefits for the United States. Cheap Chinese exports have helped keep inflation low, and China's purchase of treasury bonds has helped finance American debt.

Still a Minor Fish in a Big Pond?

For all of China's growing influence, some analysts say people overestimate its actual power.

Albert Keidel, an economist with the Carnegie Endowment for International Peace in Washington, says China is still a relatively minor player in a market where $1 trillion worth of currency trades hands each day.

"What they forget is that the American monetary authorities, in particular the Federal Reserve system, has at its control vastly larger resources than the Chinese do," Keidel says.

But if China's economy keeps growing by leaps and bounds, its influence is certain to grow as well.