China Decoupling and the Bond Market's Trade of the Century

Some argue that this financial crisis will lead to China "decoupling" from the US economy; meaning it will need to find other buyers of its exports, and will not be able to continue buying US Treasury bonds, which have the effect of propping up the US dollar's value. Instead, the decouplers argue, China will need to invest in increasing its own consumption capabilities. This will have the effect of decreased buying in the Treasury bond market while the supply of Treasuries expands as US government deficit increases -- thus making short selling long-term Treasuries one a very lucrative opportunity, if this is in fact the case.

Can this happen? If so, when?

Skeptics of decoupling argue that the decline of US demand will weaken the Chinese economy along with the US economy, and that the current structure of US consumption driving the global economy will maintain. Decouplers note that the Chinese economy will weaken, but this will force the Chinese government to invest in more infrastructure programs instead of buying Treasury bonds -- at a time when the US is planning to take on more debt and thus increase the supply of Treasury bonds. The result of this will be currency decoupling in that China will become an increasingly powerful buyer relative to the US. And from a geopolitical perspective, China is more economically aligned with Pakistan, Iran, Russia, and Hamas rather than the US/Israel/Britain economy. Thus far, we have seen China direct its buying towards domestic stimulus packages.

With that said, though, Treasury buying could go on for a while; Naked Capitalism notes that China is still buying Treasury bonds. For those who think decoupling is bound to happen, the opportunity to short Treasuries may be the best trade out there when the bubble starts deflating, whenever that may be. TBT is the double inverse ETF for the long-term Treasury bond market.

Comments

[Firat Ünlü:]

US remains the biggest economy so any talk of decoupling is BS as you'd expect any semi decently-run economy to have huge trade volumes with the US which thus would make it vulnerable in a downturn.
Yeah, they'll try to soften the blow by concentrating on domestic consumption etc but make no mistake, once the US gets going again China will be quick to regain it's export share. Don't forget that China still needs to create jobs for all the people in its West, they HAVE to export. Being self-reliant is not even an option.

"China is more economically aligned with Pakistan, Iran, Russia, and Hamas rather than the US/Israel/Britain economy."
China's foreign policy alignment is overrated, they want first and foremost stability to grow, keep Taiwan under their influence and regain power in East Asia. China's foreign policy for now is all about jobs and Taiwan. Everyting is directed towards that.

Jan 20 05:31 AM

[huangjin:]

China has idle factories and cannot find buyers for its exports. America found buyers for its Treasuries: American savers, formerly consumers of Chinese imports. Other exporting nations have also slowed purchases of Treasuries because the dollars are not flowing into their countries. What was once an open loop from the U.S. to Asia and back, has become a closed loop in America as consumption drops sharply. It is America that has decoupled from the world.

Jan 20 08:44 AM

[20smoney:]

American savers are not buying Treasuries! There are no American savers. The only entity here that is buying Treasuries is the Fed and maybe some traders. Traders are not buying these things to hold to maturity, they already have one foot out the door. The collapse of Treasuries will be HUGE.


On Jan 20 08:44 AM huangjin wrote:

> China has idle factories and cannot find buyers for its exports.
> America found buyers for its Treasuries: American savers, formerly
> consumers of Chinese imports. Other exporting nations have also slowed
> purchases of Treasuries because the dollars are not flowing into
> their countries. What was once an open loop from the U.S. to Asia
> and back, has become a closed loop in America as consumption drops
> sharply. It is America that has decoupled from the world.

Jan 20 09:15 AM

[kelm:]

To me it ultimately comes back to demographics. The US has 30 million people. The Planet has nearly 7 billion. Unless we expect the rest of the worlds living standards to always remain dramatically below ours (arrogance in the extreme) there comes a point where the demand for China's goods no longer focuses on the US. Asia was booming before this crisis hit and that was providing fuel to the thinking that Asia had decoupled. Trade within Asia was booming.It will boom again. Living standards are going up significantly in many of those countries. We will not be the center of attention for ever and I believe we will clearly see that in the next 12 months as foreign demand for our bonds dries up and the dollar drops.

I agree with the comment above that it is America that has decoupled - we just haven't realized it yet. I liken this crisis to the British losing Singapore. That truly marked the end of Empire but it was a very long time before the British truly understood they were no longer an Empire.

Jan 20 10:51 AM

[huangjin:]

Americans are saving again by reducting debt. The cash to repay the loan goes into the banking system, and the banks are leaving their reserves with the Fed, and the Fed is buying Treasuries. Ultimately, it is average Americans who are in the process of replacing the foreign borrowers. If the U.S. savings rate heads back to 10% or so, Americans can replace foreign borrowers. Whether Treasuries collapse is due to the level of government borrowing, and all signs point to irresponsible borrowing—but this is not because of a lack of demand, it is due to massive oversupply.

Jan 20 12:31 PM

[OldLimey:]

huangjin: dead right.

kelm: you're right about intra-Asian trade, but it has to be born in mind that a substantial proportion of these flows take the form of commodities, components, and sub-assemblies which are utlimately destined to be incorporated into products sold to the US and Europe. With regard to the end of the British Empire, the loss of Singapore was certainly a telling sign of decline as was the subsequent independence of India. However, to the extent one can date the actual end I personally would look at the Suez crisis - the point at which a policy central to the 'Imperial' view of the world was forcibly reversed by the US threatening Britain's financial solvency if forces were not withdrawn from Egypt. The US had of course already been in the ascendancy for several decades, but Suez was the point at which it finally dawned on the British establishment that the country was no longer an independent actor.

Jan 20 02:31 PM

[isaac the t...:]

I don't think you speak for the Chinese when you say they are more part of the Hamas economy. You couldn't be more wrong about how they see themselves or the future of the world. They are moving ahead with their own style of modernity. Not trying to move into a cultural stone age like Hamas or the Taliban.
And I would also corrctly point out that the majority of the people in Pakistan, Iran, and Russia would much rather be a part of the modern economy of the world- despite their failed leadership.
To sum things up-China couldn't give a rats ass about hamas.

Jan 20 02:45 PM

[henarl:]

I agree that you can't compare China with Hamas. Whatever problems China may currently have, they are a huge sovereign country with the world's largest population and a history going back thousands of years. The rest of the world will have to contend with China, for better or worse, far far into the future.
Hamas, on the other hand, is a ragtag collection of suicidal zealots with no country and is just a client of Iran, who would dump them in a minute if it suited their agenda. Their military importance is demonstrated by the fact that over 1,300 Palistinians were killed against 13 Israelis in the recent conflict. At an attrition rate of 100 to 1, Hamas is a loser.

Jan 20 03:39 PM

[isaac the t...:]

Hey Simit,
I have an idea. You invest in Hamas, I'll invest in China.
Also, please note the Isrealis attempted to hand over the Gaza strip to the Palestinians for self-rule as a soverign territory- something never offered to them under hundreds of years of rule by Eqyptians, Ottamans, Jordanians or Brits.

By the way, hamas aside, I agree with much of your observations.

Jan 20 04:32 PM

[puttster:]

Whaa....? China may stop buying US bonds??? www whhaaatt??? My God man! What an incredible stroke of insight!!! You have finally connected the dots that thousands, maybe millions of people could not! You have exposed the emperor with no clothes! Nobel prize for genius and originality coming up!!

How do you think of this stuff!!! How???

Jan 20 05:27 PM

[doubleguns:]

If US households begin an ernest saving plan in the neighborhood of 5-10% the world recession will get really ugly really fast(potential depression). Of course if the treasury market goes down the tubes the interest rates on those treasuries will get really tasty and the 5-10% Americans might save would be attracted to those bonds. We would be saving, crushing world economies and getting a large payout from the bonds. From a selfish perspective I am all for that. I just don't know how the world would deal with that situation. Hopefully not a WWIII.

If we are saving we aint spending and that would be a disaster. unfortunatly it needs to go down this way so we can get our house in order. Seems inevitable that things are going to get worse and the treasuries bubble could pop if foreign countries begin to cash in the treasuries to spend the money at home. The more americans save the more likely this will happen but we need to save in the worse way.

The pill that cures could also kill.

Jan 20 05:51 PM

[Glen Bradford:]

You are on the right track. Why don't you own FXI or TBT?

Jan 21 12:18 AM