Current trends show that in the next few years, Chinese foreign reserves will increase steadily. With renminbi appreciation the U.S. dollar will depreciate. This means the value of China's dollar reserves will decrease significantly. Therefore, China must change its foreign reserve structure before losing out.

"Dollar assets should make up about 60 percent of all Chinese foreign reserves," said Liu.

Two years ago, China planned to diversify its foreign reserve structure.

On May 31 this year, the vice governor of the Chinese central bank Wu Xiaoling stated clearly that China didn't mean to reduce the dollar assets in its foreign reserves, but that the importance of the euro as a reserve currency is certainly on the rise.

The Chinese central bank is also considering whether or not it would like to increase the proportion of its holdings of Japanese yen and gold. Meanwhile, China is investing its U.S. assets to reduce losses caused by the dollar depreciation.

China is planning to set up a national foreign reserve investment company that will manage $200 billion of the Chinese foreign reserves. While not yet officially established, the company has already taken some action. In May it invested $3 billion in the biggest U.S. private equity firm-the Blackstone Group.

In 2006, the State Administration of Foreign Exchange canceled restrictions on Chinese investment abroad and said it intends to support domestic companies as they begin to invest overseas. Before, domestic companies could only invest at most $5 billion abroad each year and they had to get approval from the supervisory department if their purchase of foreign reserves surmounted $10 million.

"Those measures didn't reduce the dollar assets, but will reduce its proportion in the Chinese foreign reserves," said Liu.

No abrupt reduction

Professor Liu said that in order to optimize foreign reserves, China will proceed in a stable, safe and floating manner. That means diversification of the foreign reserve structure will be a gradual process and China won't cut its U.S. bonds substantially.

Tan Yaling, senior researcher with the Bank of China, agreed with Liu's opinion. She said that U.S. bonds are still one of the most stable investment objectives, as "the U.S. economy is far better than that of other countries."

Tan contended that compared with the United States, the economic structures of the European Union and Japan are relatively weak and are less mature and steady. As a result, currency stability of those countries is not as strong.

He Fan, a research fellow with the Chinese Academy of Social Sciences, said China's stance in regard to holding U.S. bonds is a great concern of the global financial market, thus China is faced with a conundrum: U.S. dollars are undergoing a depreciating trend, and if China sells the U.S. bonds in large amounts, the dollar will further depreciate substantially, leading to a plunge in the value of Chinese foreign reserves. However, if the U.S. economy is in trouble, the Chinese economy will also suffer because the United States is the biggest export destination of China.

He said it seems necessary to reduce the proportion of dollar assets as other currencies appreciate. But in effect, China doesn't want to see the chain reaction caused by a large-scale sale of U.S. bonds. For instance, selling bonds will help increase the U.S. interest rate and the cost of loans, which will result in a slump in consumption. The consumption slump will reduce U.S. imports from other countries, thus exporting companies of other countries-especially China-will be hurt enormously. In the end, China's economy will suffer.

The United States is the most powerful country in the world and its status as such will continue over a long period of time. Whatever currency-euro or yen-cannot challenge the dollar's dominant status. No other economies are as attractive as the economy of the United States. When China-U.S. trade relations deepen and political cooperation grows stronger, China will never and should not ignore the long-term value of dollar assets.

Tao Dong, chief economist of Asia-Pacific region with Credit Swiss First Boston, stated confidently that "China won't sell dollars as people fear and it will continue to buy dollar assets this year."