China to Ask for U.S. Treasury Guarantees

Yesterday, a day when the schizophrenic market's anti-psychotics finally kicked in, the scariest piece of news did not come out until very late, and this one has the potential to really throw the Treasury a curveball. Yu Yongding (cruel, cruel parents), former advisor to China's Central Bank is agitating China to seek guarantees on its $682 billion of U.S. Treasury Holdings, so that these do not get eroded by "reckless policies."

Bloomberg had the following to say:

"The U.S. should make the Chinese feel confident that the value of the assets at least will not be eroded in a significant way,” Yu, who now heads the World Economics and Politics Institute at the Chinese Academy of Social Sciences, said in response to e-mailed questions yesterday from Beijing. He declined to elaborate on the assurances needed by China, the biggest foreign holder of U.S. government debt.

In [upcoming] talks with Secretary of State Hillary Clinton, China will ask for a guarantee that the U.S. will support the dollar’s exchange rate and make sure China’s dollar-denominated assets are safe, [and that this] would be one of the prerequisites for more purchases.”

“The government will be a net buyer of Treasuries in the short-term because there’s no sign they have changed their strategy,” said Zhang Ming, secretary general of international finance research center at the Chinese Academy of Social Sciences in Beijing. “But personally, I don’t think we should increase holdings because the medium- and long-term risks are quite high.”

While China may be posturing after suffering $5 billion in losses on its $10.5 billion investments in Blackstone (BX), Morgan Stanley (MS) and TPG, this is a very serious threat. Granted, China does not have many options of where to invest its surplus cash, although refocusing on its own economy and expanding its fiscal assistance policies (a la what the U.S. is doing) is an option, thereby making it less of a sure investor in U.S. debt. Yu further confirms this threat:

A decline in reserves “isn’t likely because of China’s huge twin surpluses,” Yu said. China “should diversify its reserves away from U.S. Treasuries if the value of China’s foreign-exchange reserves is in danger of being inflated away by the U.S. government’s pump-priming,” he said.

Although this is most likely a preamble to a diplomatic escalation arising from Geithner's initial claims about currency manipulation by China, the threat that the U.S. may lose its largest foreign debt purchaser should be enough to make people in the administration very worried. China is currently in a position of strength relative to the U.S., and only an altruistic desire to cooperate from a game theory p.o.v. will prevent a huge blow to the U.S. economy (which would of course impact China as well).

In all likelihood, China is reminding the U.S. that it is no longer the big dog in the economic playground and that wisecracks like Geithner's, or a neo-unilateralist economic policy will no longer be tolerated.

Comments

[Larry House]

Very interesting. Everyone wants a guarantee! Our government is about to get a credit limit decrease and an interest rate increase from its credit card issuer!

2009 Feb 11 02:34 PM

[Dave Wrixon]

That was obvious to anyone with half a brain.

If the US is expecting China to free carry them, then think again. These guys are very clued up on economics. If you try to take them for suckers, you will regret it.

2009 Feb 11 02:55 PM

[Firat Ünlü]

Back in the day (pre-Republic) one option was to simply have another tribe's prince in your court and vice versa.
Geithner in exchange for Yu? ;)

China's only recently become America's biggest creditor, Japan is not far behind and I can see this opening up a process that could turn out very problematic in terms of a) assets and b) public opinion.

2009 Feb 11 03:04 PM

[thinkb4uwrite]

Not to take the thunder out of your article,Tyler.

Indeed there are risks of possible currency wars and protectionism from bad US monetary and trade policies but not from seemingly provocative comments. The Chinese response was actually favorable to the comment Geithner made at his confirmation hearing. His comment, you recall, was that President Obama and other economists were concerned that the yuan was being manipulated (possible devaluation of the yuan so that Chinese-made products would have purchase advantage of being lower in cost than before to consumers in the US). But Chinese officials said they were not concerned that any trade issue was at stake and would continue to dialog.

The only danger I see is that we will be represented by Hillary Clinton who hasnt so much as a lick of foreign policy experience in matters that are extremely crucial to resolving global financial issues and calming fears and tensions that develop everywhere as we continue to move deeper into the global financial crisis. Oh Boy!

2009 Feb 11 03:09 PM

[bosun.j]

Listen up! There's a new sheriff in town!

2009 Feb 11 03:10 PM

[MattGigEm]

I agree with everything you said except for this: "While China may be posturing after suffering $5 billion in losses on its $10.5 billion investments in Blackstone (BX), Morgan Stanley (MS) and TPG." The Chinese think very long term. They may be posturing but I doubt they are concerned with what is probably an inconsequential and temporary $5 billion loss.

Good article.

2009 Feb 11 03:45 PM

[Spook]

Most comment I saw were from the thinking of an American, how about turning this around and think like a real old Chinese. There is an old Chinese saying that a Chinese will make an investment or business risk even if it meant loosing his head, but a Chinese will not take risk if it mean loosing his money.

The Chinese have no concern if this become a trade war or a political issue, as long as money can be made on the side, but if this meant that China investment on US like BX, MS and Fannie/Freddie will loose its value, China will think twice and may possibly one day come up with an alternate solution to park its excess foreign reserve somewhere. Like cornering metals and mineral source and supply for its future consumption and use, to build cheap product to sell to American.

2009 Feb 11 09:28 PM

[Charlie Bottle]

What would be the form of such a guarantee? A verbal assurance? A fiscal austerity plan a-la IMF (this is know in the development agency world as conditionality)?

The first is worthless the second impossible (at least for now).

2009 Feb 11 10:12 PM

[Roger Knights]

Possibly Yu Yongding and China realize that the US cannot grant such a guarantee, and that if it does do so it cannot fulfill it. Thus the purpose of this request may be to have a good excuse to start selling Treasuries, either now or somewhere down the road. (Of course, there's always the remote possibility that a guarantee will have some value, so why not ask for it?)

2009 Feb 12 01:08 AM

[nova]

It is about the time for Asia to state that their geopolitical interests will not be prostituted to please their former colonial masters.

The "payback time" will come later.

2009 Feb 12 09:12 AM

[know nothing]

It's just buisness! Take out a loan and put up collateral, pretty simple, who on earth, in their right mind would make a loan without a a promise of repayment or assets for collateral? I mean besides the U.S. gov't loaning to the banksters, of course.

2009 Feb 12 10:50 AM

[huangthomas]

I saw a few posting here. They are mainly American concerns, but being camouflaged as Chinese concern. It makes me laugh. Why should China care about collapse of that great power, America. They will send you convalescence or even pay an official visit to you when you are down in the sewer. The cost to them is very limited, but the cost to American are tremendous. American are desperate, because they have no control over government policy on rescue missions and trying to use "Chinese tick" in American policy debate.

2009 Feb 12 11:23 AM

[kelm]

This is one of multiple communications from China, delivered by various avenues that are telling the US, in a very diplomatic way, that we need to tend to our fiscal house while solving this crisis. China thinks long term and they recognize that long term the US will not be the dominant player but rather one of a number of dominant players. Indeed our own National Intelligence Council 2025 report released last fall states that by 2025 the US will be one actor in a multi-polar world. China is thinking long term. they are telling us that we are running a long term risk of devastating our economy if we don't control our deficits. This should not be viewed as a threat but rather as a valuable trade partner giving us sound advice.

2009 Feb 12 11:24 AM

[ssks]

Not so long ago Paulson was in China lecturing his audience there on the superiority of the American way of consumerism and finances. Time for him to eat humble pie and rapped on the knuckles.

2009 Feb 12 03:34 PM

[TeresaE]

First we sent them our jobs

Then we sent them our machines, patents and investments

Then we borrowed from them

Then we sent huge amounts of our individual incomes back to them to buy the goods made by them with our previous jobs, machines and patents.

Now, there working class is nearly THREE times our ENTIRE population and growing daily. GM is now selling more cars in China a month, than the US.

And Europe did the same thing to.

When the Russian wall fell, China's leaders made a very telling statement. "We will destroy the West without ever firing a shot".

Mmmmm, think we are there yet? I do. They don't NEED us anymore. They are slowly raising their prices even as sales fall and still, what does our government do? They GUARANTEE China more of our money.

Wake up people. All they have to do is start the squeeze, especially when 70% of our processed food and 80% of our medicine comes from them.

If they wanted to accelerate this mess and send us into anarchy it wouldn't take much.

And, just so we all wake up, when our government needs to borrow $2-3 TRILLION to fund all the plans from THIS week, and China is already balking at the $600 billion they currently hold, just where on the earth does Congress and our President think they are finding 4 or 5 times that amount? Germany? UK? MidEast?

Fools and idiots are selling out our children into indentured servitude and a communist master. Yet, we let them.

2009 Feb 12 08:13 PM

[dz2009]

People:

The current problems in US are self-making. You should ask why you electedd Bush 8 years ago, and why you, your spouse and in-laws speculate on homes and condos you don't need to live in.

>> Fools and idiots are selling out our children into indentured servitude and a communist master.

Better ask yourself on what you did in last 8 years, before pointing out a big finger

2009 Feb 13 07:15 PM