China should use its foreign-currency reserves, the world's largest, to buy gold and oil as a hedge to guard against the risk of a sudden drop in the U.S. dollar, said an adviser on the central bank's 13-member policy board.

The country has 1 percent of its reserves in gold, compared with more than 70 percent in the U.S., and rising demand may add to gains in the metal that pushed prices to a 26-year high in May. Booming exports and investment doubled Chinese reserves to $819 billion in the past two years, with economists estimating more than two-thirds of the cash went into U.S. Treasuries.

"China has more than enough foreign-exchange reserves," said Yu Yongding, who advises on policy as a committee member of the People's Bank of China. "While they cannot be reduced sharply all at once, China has decided to take measures to curb their growth rate and diversify investment of its reserves."

The central bank would likely use new reserves to diversify away from the dollar and into other assets, rather than shifting current holdings, he said in an interview in Beijing on May 26. China is the second-largest foreign investor in U.S. Treasuries.

"We don't want to cause dramatic fluctuations in the foreign-exchange and securities markets," said Yu, who is also the director of the Institute of World Economics & Politics at the city's Chinese Academy of Social Sciences.

China last year attracted more than $60 billion of foreign direct investment, while its trade surplus tripled to a record $102 billion in the world's fastest growing major economy.
'Fourth currency'

The country's foreign-exchange holdings as of March 31 surged to $875.1 billion, up more than $50 billion from end-2005 and overtaking those of Japan as the world's biggest.

"Central banks will use gold as a fourth currency instead of the dollar, euro and yen" to hedge exchange-rate risk, said George Kapasakis, a senior foreign-exchange trader at Mizuho Corporate Bank in Sydney. "Gold will be underpinned."

China should follow Singapore's lead in setting up a body to manage its reserves, said Yu, who spent three months there for a "private" visit from last December, including a "personal exchange" with friends at the island's central bank.

Government of Singapore Investment Corp., which handles more than $100 billion of the city-state's reserves, says it invests worldwide in equities, fixed-income and money-market securities. It has about 10 percent of its funds in property.

"China needs to establish a separate body to oversee and invest the reserves to seek higher returns and to avoid losses in case of a big depreciation in the U.S. dollar," Yu said. "We need to use some of the reserves to buy other assets such as gold and strategic resources such as oil."
'Intervene less'

Gold has rallied about 25 percent this year, reaching $732 an ounce on May 12, the highest in 26 years.

Foreign reserves have risen in Asia partly because central banks in countries such as China, Korea and Taiwan buy dollars to keep exchange rates stable and protect exporters. The three economies are among the world's top five holders of reserves.

Finance ministers from the Group of Seven nations said in Washington April 21 that it is "critical" for governments in Asia, and particularly China, to let their currencies appreciate to reduce trade imbalances that threaten global economic growth.

Yu said his government will buy fewer dollars and reduce its influence over the exchange rate as Chinese exporters learn to cope with a stronger yuan.

"Personally, I think that China's export enterprises are more resilient than we expected; they will become even more resilient," he said. "Then the government will intervene less to allow the exchange rate to be decided more by the market."
Policy statement

The central bank yesterday said in its quarterly policy statement it will start to withdraw from the currency market, reducing the "frequency and strength" of its actions. U.S. lawmakers accuse China of artificially weakening the yuan to fuel an export boom that has expanded the U.S. trade deficit with the Asian country to a record for five straight years.

The yuan today rose to 8.0205 per dollar as of 3:30 p.m. in Shanghai, from 8.0215 yesterday, according to Bloomberg data.

"Yu's comments echo statements in the last monetary policy report that the People's Bank of China should change its way of thinking and adopt an innovative approach to achieve a balanced external account," Qing Wang, a currency strategist at Bank of America, said in Hong Kong. "They will adopt further measures to facilitate outflows and ease appreciation pressure."

The People's Bank of China sets daily reference rates for trading around which its currency is allowed to move, buying and selling the yuan to keep its value stable.

The Chinese government this year has allowed individuals and companies to increase investments abroad, and to keep a greater proportion of their foreign-exchange earnings overseas. The U.S. trade deficit with China reached $201.6 billion in 2005.