Why China Will Continue to Buy U.S. Treasuries

Think American workers have it bad? It's worse in China.

You may not know that by scanning the headlines. Late last year the Chinese government passed its own stimulus package of about $600 billion, to meet its target of 8 percent GDP growth. That's right, 8 percent. That would be outlandish growth here, where the economy is now shrinking, not expanding.

But in China, that's barely enough to keep a restless workforce employed. And the government might not be able to make its 8 percent target. Unemployment is soaring, and there's even a possibility that economic woes could lead to angry public protests like those that preceded the 1989 Tiananmen Square massacre.

Since Tiananmen, America and China have become deeply linked to each other. Americans, obviously, buy a huge amount of imported Chinese goods—about $340 billion worth in 2008. Much of the cash that flows back to China gets invested in U.S. government securities, which helps keep U.S. interest rates low. China even invests directly in American firms. In 2005, Chinese computer maker Lenovo (LNVGY.PK) bought IBM's PC division for $1.75 billion. In 2007, the Chinese government bought a $3 billion stake in the Blackstone Group, the American private equity firm. Historian Niall Ferguson, author of The Ascent of Money, even conflates the two nations as one: Chimerica.

Since the two countries are so closely linked, I asked Wei Li, a business professor at the University of Virginia's Darden School of Business who also teaches at the Cheung Kong Graduate School of Business in Beijing, for an update on the Chinese economy, and how changes there are likely to affect the United States. Excerpts:

How is the global recession affecting China? The outlook for China is very grim. Much more grim than for the United States. There are two main drivers: Housing and exports.

Ten years ago there was a housing shortage in the cities. But now there's a housing glut. The market boomed, and now there's a huge bubble. Price of housing in Beijing and Shanghai is sometimes higher than Hong Kong or Tokyo. One reason is there's very little opportunity to invest elsewhere. That led to lots of speculation. It's mostly urban. In rural areas, you still build your own house.

Is the housing bust in China worse than in the United States? Housing in China is a much bigger deal than in the United States because people just started buying. For many Chinese they were first-time homeowners. Prices haven't really fallen yet, but they have to. If they don't let prices fall, something else has to adjust. Either the price falls or quantity adjusts. If the quantity goes to zero, nobody buys refrigerators or tiles, or hires electricians or architects. The bust has been going on about one year now, and accelerated since the last quarter of 2008.

What about exports. There's been a double digit decline. For every 1 percent rise or drop in U.S. consumption, Chinese exports go up or down by 10 percent. The effect is 10 to 1.

So with consumption down in the U.S. by about 2 or 3 percent, you mean that exports in China have fallen 20 or 30 percent? That's right.

The unemployment rate in the United States is 8.1 percent right now. Is it higher in China? According to Chinese Academy of Social Sciences (CASS), the unemployment rate in urban areas in the end of 2008 was 9.4 percent, significantly higher than official jobless rate of 4.0 percent. It's probably higher now, since the Chinese economy experienced a marked slowdown since the last quarter of 2008. In addition, in 2009, 6.1 million college graduates are looking for jobs. These figures all underestimate the severity of unemployment in China. The unemployment stats count only jobless rate in urban areas. When rural migrants cannot find jobs, they often return home and subsist on their land.

Those are big changes. What are the implications? In the United States, the savings rate will go up. Up till now, why save if asset prices are going up? But now, with so much wealth destroyed, people have to rethink that. So consumption will go down as a percentage of GDP. So demand for Chinese exports will be somewhat less. The export engine in China will keep running, but demand will be much less.

That means the U.S. trade deficit will be smaller, right? Yes, the U.S. trade deficit will have to be smaller. As these bubbles burst, a lot of countries will re-look at their competitive advantages. The United States will be okay because it's a much bigger market. It won't break the social fabric of the United States.

But in China, it could be different. A lot of people in China are like people who just got a job and haven't yet accumulated a lot of wealth. They won't be able to maintain their lifestyle. China has a very nice veneer in the big cities, and great infrastructure, but there's not always a lot beneath the veneer. Unemployment is going up faster in China.

Can't the Chinese government pull the old levers of a command economy, crank up spending, and keep people employed? That's what people may think, but the Chinese economy is so much bigger than the government can control. If you think U.S. consumers are scared, Chinese consumers are equally scared, if not more. Stocks in China are down 60 percent. The new middle class who owns multiple apartments is living on a lot of borrowed money. They're in very bad shape.

Some people worry about the fact that the Chinese government owns several trillion dollars worth of U.S. government securities. You know the argument: If the Chinese sold their holdings the U.S. economy would collapse. China could conduct economic warfare against America. People worry about China buying Treasuries, but for China, they don't have a choice. There's really no place else they can put their money. To say that China is somehow controlling the U.S. economy is laughable.

So with China in tough shape, will Chinese influence fade? I think Chinese influence will still grow, but it has to be different. The Chinese approach used to be, speak softly and make a lot of money. That's not working any more. The system is flawed. If China wants to continue to benefit from globalization, China needs a voice.

What's the risk of some kind of serious instability inside China? Could there be another event like Tiananmen Square in 1989? A lot of people are unemployed. Not just rural labor. We're talking about highly educated college grads. When enough of them can't find jobs, they'll look for something to do. The events in 1989, that was described in romantic terms in the press in the United States and in the west. Democracy taking root, that kind of thing. But that happened because of high inflation, a lack of jobs after students graduated. A tighter money supply made it harder for companies to hire workers.

So could that happen again? It's already developing. Many grads from 2008 still don't have jobs. More students will graduate this June without jobs. We're talking about millions of people. But I don't think another incident like Tiananmen Square is likely because everybody got smarter after that. Many students will be happy to work for free as long as they can learn some skills. Today, more families have savings.

What's the thing to watch for, to tell how serious conditions get inside China? When people are literally starving. It could happen. Social insurance is much less than in the United States.

Disclosure: no positions

Comments

[Mr. Ed, Jr.:]

Very informative article, with great insight. Thanks

Mar 13 03:42 AM

[Dave Wrixon:]

If there wasn't an issue then Premier Wen would not be publicly stating his concerns over China's investments in US Treasuries. Anyone that knows anything about Chinese politics will know that this very public statement pressages some kind of proactive initiative to try to mitigate the problem. When I say mitigate, I mean mitigate it for China.

Mar 13 04:34 AM

[kelm:]

Good article.

There have been a number of communications form China about their level of investment and trust in US investment. Wen's comments about needing guarantees was stated before Clinton's visit and reiterated this week. China pulled all of their banks from bidding on AIG Asian assets at the last minute before the auction was to take place which strikes me as a certain sign that they are uncomfortable with US financial institutions (they got burned on the Blackstone deal though it may work out in the end).

China does not have to dump their Treasury holdings, only not buy as many or gradually sell them off to fund acquisitions to cause major headaches for the US. That does not mean they need to try and cause us headaches. China will do what China needs to do (just as we would). Keep in mind the US sold $890 billion in debt last year and will auction between $2.0 and $2.5 Trillion this year. China will be barely able to buy what they did last year let alone solve our problem of selling the rest.

Mar 13 09:59 AM

[Mad Hedge F...:]

I am repeating my comment on Bill Zelinski's piece which I think is relevant. The Chinese government has expressed “concern” about the safety of their $696 billion investment in US Treasury bonds. What they are not telling you is that they are even more “concerned” about the hundreds of billions of Fannie Mae, Freddie Mac, GMAC, and other agency debt, which is either now untradeable or has gone into the toilet. And “concerned” they should be. Not only is some of the paper they own now worthless, there is an impending 50% devaluation of the dollar in the cards which is the guaranteed result of current US government printing press policies. One of the great luxuries of running a dictatorship is that you can skip mark-to-market accounting. The government entities that own all of this garbage are carrying it on their books at par because they intend to hold it to maturity. If China used mark-to-market they would have plunged into another civil war by now. Expert to hear more “concerns” from Japan, Singapore, and the sovereign wealth funds that are in the same boat.

Mar 13 10:06 AM

[Mike Stathis:]

Rick, you are so wrong on so many accounts that for me to pick apart your article would consume my entire day. This piece is yet another example of the journalistic irresponsibility we have suffered in America for years.

I would suggest you either leave the economic analysis to experts, or else find credible sources that aren't Wall Street or government hacks.

For starters, anyone familiar with China knows well about their gov bail out. China is being affected like most every other nation but China will mount a real recovery in a few years, unlike America. China has a real economy, unlike America's Ponzi scheme economy which is highly dependent on foreign financiers to keep it afloat. And China does not have a $72 trillion deficit in its entitlements programs over the next few decades like America.

There are so many issues I really don't have the time to address. All I can say is that I would advise you to stick to one topic and learn it well. And I would advise against that topic being anything to do with the economy. Perhaps you might consider going back to writing on the Big 3. Alternatively, you might consider applying for a job at CNBC.

Mar 13 11:24 AM

[HChang:]

Check your facts plse. Your ignorant is laugable: Beijing & Shanghai proprty more expensive than Tokyo and HK.And the 10:1 export consumption ratio. Suggest you go the the chinese government website to check the numbers for all the chinese trading partner, including Japan, EU, etc. You made it sounds like China depends solely on US and not the other way round. And it is not that China has no other place to invest, if you really think so, i feel sad for your myopia. The world does not consist of only US and China. It's this kind of arrogance that may trigger China to dump US assets and hold the US as an economic hostage. I don't blame you, you are 10K miles away trying to imagine things in China after reading the garbage from news. Buy an air ticket and stay there for a month to check on the ground....you will write something different.

Mar 13 12:26 PM

[anarchist:]

Mike, you spent the best part of three paragraphs criticizing Rick's article, so take the time to outline your reasonings and tell us why you know more about China than the guest, Wei Li,interviewed by Rick.


On Mar 13 11:24 AM Mike Stathis wrote:

> Rick, you are so wrong on so many accounts that for me to pick apart
> your article would consume my entire day. This piece is yet another
> example of the journalistic irresponsibility we have suffered in
> America for years.
>
> I would suggest you either leave the economic analysis to experts,
> or else find credible sources that aren't Wall Street or government
> hacks.
>
> For starters, anyone familiar with China knows well about their gov
> bail out. China is being affected like most every other nation but
> China will mount a real recovery in a few years, unlike America.
> China has a real economy, unlike America's Ponzi scheme economy which
> is highly dependent on foreign financiers to keep it afloat. And
> China does not have a $72 trillion deficit in its entitlements programs
> over the next few decades like America.
>
> There are so many issues I really don't have the time to address.
> All I can say is that I would advise you to stick to one topic and
> learn it well. And I would advise against that topic being anything
> to do with the economy. Perhaps you might consider going back to
> writing on the Big 3. Alternatively, you might consider applying
> for a job at CNBC.

Mar 13 12:37 PM

[css1971:]

I'm sorry, you still haven't made a very good case for China to send their money to the USA rather than to keep it in China.

Mar 13 01:14 PM

[samwise:]

The MHFT strikes again! Couldn't agree more. As it relates to Treasuries and as was so aptly put in this interview, the Chinese and even all of East Asia had no choice. Agency debt, on the other hand, is a whole 'nother animal. Uncle Sam does things not because he wants to but because he has to. Nationalizing Fannie and Freddie was only done because there was a real fear of ticking off the wrong people. Then the Democrats won and decided to take all their clothes off and went running through the poppy fields of love by ramming through the biggest spending increase in American peacetime history. Needless to say the Chinese made a phone call and asked, "what the hell are you doing. I thought we had a deal." That's when BO got a lesson in geography. You know the deal, "China is located here on the map. They have many people. They're called "China-men..."

Mar 13 01:42 PM

[User 371080:]

The interviewee is biased in favor of multi-nationals. Makes much of his answers questionable.

Mar 13 01:43 PM

[Even Walser:]

Some people worry about the fact that the Chinese government owns several trillion dollars worth of U.S. government securities. You know the argument: If the Chinese sold their holdings the U.S. economy would collapse. China could conduct economic warfare against America. " People worry about China buying Treasuries, but for China, they don't have a choice. There's really no place else they can put their money. To say that China is somehow controlling the U.S. economy is laughable."

My point all along!

Mar 13 02:03 PM

[mkreisel:]

China has more than 2 trillion in foreign currency reserves, less than half of that goes into US treasuries and other agency debts. Where do they invest the rest of them? It looks to me that they have been pursuing an asset allocation strategy all along.

Mar 13 02:39 PM

[icyicym:]

Ok, i don't understand the whole hoopla here. Please remember the following facts:
a) All U.S debt is denominated in USD
b) USD is FIAT currency.

So how on earth can U.S ever run the risk of insufficient debt demand at low rates ? In the worst case, the fed can monetize unlimited amount of treasury debt.

Infact, with a positive slope yield-curve, thats what the Fed ends up accomplishing in-directly with the banks doing their bidding through carry trades on the curve.

Now, inflation is another matter - but risk of not being able to monetize debt ? Geez, what the heck is everybody drinking.

Mar 13 02:57 PM

[Billy Gee:]

The IMF and WTO are to Premier Wen what the SEC is to Chairman Madoff. Regulatory insitutions to sneer at and rules to ignore. The world markets in goods, services and financials have been undermined and trust has lost its meaning.

Mar 13 03:00 PM

[wisurvey:]

They do have a strategic asset allocation....and I think we will see them more aggressive in African and Aisan commodities (Rio tinto, Russian oil, S. Africa gold? Venezuela oil? the list goes on and on.....). China has a unique historic opportunity to cover a lot economic wealth and resource storage ground in a very short period of time (1.25 billion is a LOT of people). Too bad we have Pelozi, Dodd, Reed, etc, etc.......

Mar 13 03:03 PM

[Tony Daltorio:]

The author follows the typical "media/CNBC" logic. The epicenter of the financial earthquake is Wall Street,USA -yet America won't be affected greatly but some poor farmer in Western China will be devastated. Go back to selling swampland in Florida.

Mar 13 03:07 PM

[nova:]

Fact
* For the last 40 years, China was aggressively developing their economy, specifically high-tech industrial base by buying and stealing everything of value they could. The results are quite impressive.
* China is a communist country. Consequently, their leaders just marginally need to please their general population. Their security and enforcement apparatus is stable and efficient.
* China is not Japan. They have no need to please the USA. They do not have American military bases on their territory. China has shown many times, when it is necessary, from for their leaders point of view, they are ready to engage the USA in major confrontation.
* The total nightmare for the USA will be close alliance of China with Russia and/or Japan
* China is poor in natural resources to support their future development. China understands this very well and is developing means and way to secure supplies.
Consequently, it is inevitable that China and the USA are on a confrontation course.

Conclusion
China is about to diversify its US$ denominated assets and investments. This is in China geopolitical interests.

Mar 13 03:09 PM

[mac.barron:]

Make no mistake: China will do what is in China's own best interests. We all know this but it leaves the question open as to what will in fact be in their best interests.

ONE: They could decide to cut their losses and get "out" of U.S. Treasuries but who would be willing to buy them? The alternative is to stop buying any more which would, no doubt reduce the value of their current holdings but protect them from further losses.

TWO: They could stay on board. This path would have them falling with our economy as we continue to try to print our way out of a black hole of debt.

Ultimately one has to ask one's self: "what is the real value of a U.S. Dollar?"

I think that the U.S. Dollar does still have value because it can buy a piece of property in what is still, to be honest, a pretty great Nation. I honestly can't think of a more fundamental reason why the U.S. Dollar is still holding up as well as it has. I'm not being jingoistic either, for all of our faults, the U.S.A. is still the Beacon of Freedom and the place where the future of the world will be decided. If you want a front row seat, you still need to pay in greenbacks.

Is the road ahead rocky? Yes. Is it an uphill climb? Yes. Will we make it? I don't know.

But for now, at this very second, I am not convinced that China will be pulling the plug any time soon.

Mar 13 03:45 PM

[Sober Realist:]

Good one mac.barron. I agree with you. You should read Global Catastrophes and Trends: The Next 50 Years and see what the author has to say about America and China.

Mar 13 03:54 PM

[MichaelJ007:]

decent article. at least it offers a sensible reality to all those that fear China holds such a strong financial position over the US via TSYs alone. Seriously, they wouldn't liquidate their holdings at market bottom. That'd be self destructive. However, China is well aware of its need to diversify and they will act accordingly.

Mar 13 04:57 PM

[xiang:]

Wen wants to buy Au, Ag, Pt, Pa, Cu and oil

Mar 13 05:10 PM

[css1971:]

"Seriously, they wouldn't liquidate their holdings at market bottom."

Sell high buy low. Classic contrarian strategy. Hell. I'd do it.

Mar 13 05:16 PM

[Gary A:]

Only international bankers who have an interest in protecting their derivative positions on bank bonds would not claim to be worried about Chinese investment.

If the Chinese do not invest, however, those same bankers are really bluffing. They have nothing to back up their bluff. The banks need to share the pain of deleveraging with the treasury and so far they are refusing to allow a haircut of the corporate bank bonds.

If they persist in their usurpation of the sovereignty of the United States and if the United States attempts to pay for this deleveraging through the treasury alone, then the dollar will tank, the Chinese will lose a bundle and demand for US bonds will dry up.

Our government needs to throw off the bondage of international banker control and listen to our main investor.

Mar 13 06:48 PM

[Tony Petroski:]

The Chinese can press-gang young men into the Navy and send them to sea to harrass U.S. shipping. That would absorb some of the unemployed.

Mar 13 08:09 PM

[Aristophanes:]

Recycle their current T-Bills. Yes. Purchase new long bonds. No.

Holding the US$ and ability to deficit finance hostage? Priceless.

Mar 13 09:29 PM

[Thomas Wagner:]

I wrote about this senario several months ago and at the time no one believed that the chinese would contemplate selling there Treasuries. I see them trading them for commodities and investments in latin america and africa. I continue to be amazed at the sheer audacity of the Americans who state " they have to buy, were are they going to go". If this continues were on track for 14% interest rates and double digit inflation. A Chinese sell off of treasuries will make the 1974 oil shock look like a walk in the park.

Mar 13 11:02 PM

[expat in China:]

Nova is right!
China has resources at its finger tips Australia, Venezuela, Africa nations, Russia, Iran, and many others and could buy Canada in a day if it wanted.

The USA will have to please its lenders just like everyone else and the lender will reduce its exposure if there is no compliance.

Newman is right!
China needs customers more than needs money in the bank and the Cash flow is keeping the fair tale alive. The not so secret society “Jiang Hu” makes it impossible to evolve the quality of the exports to satisfy developed markets.

China is building new customers in emerging markets where cost effective quality products are accepted and regulations can be side stepped.

Marc Baron is right!
Chinese rich send their money out of the country.

The long term planning of the central government will reduce its exposure and the dollar purchasing bubble will shrink not bust!

The coming inflation 15 -17% will make China richer with all the commodities they are acquiring globally.

Mar 14 12:08 AM

[Spook:]

> Fact
> * For the last 40 years, China was aggressively developing their
> economy, specifically high-tech industrial base by buying and stealing
> everything of value they could. The results are quite impressive.

yes, which is why Russia decided not to sell SU-33 to China this week, Chinese have quiet impressive reverse engineering capabilities, Huawei product similarities with Cisco high end product, clone iPhone with more functionalities, complete copy of Mercedes-Benz automobile, and the US nuclear warhead design in Chinese possession couple years ago.

>
> * China is not Japan. They have no need to please the USA. They do
> not have American military bases on their territory. China has shown
> many times, when it is necessary, from for their leaders point of
> view, they are ready to engage the USA in major confrontation.

Yes, the Hainan E3 incident years ago, the USS Impecable incident last week. The PLAN build up in recent year is causing an alarm.

*
> The total nightmare for the USA will be close alliance of China with
> Russia and/or Japan

What the west fear most is the unification of Taiwan with China, the scenario is total control of South China sea. The Japanese is already against this scenario.

Mar 14 12:39 AM

[Spook:]

More likely is scenario One


> ONE: They could decide to cut their losses and get "out" of U.S.
> Treasuries but who would be willing to buy them? The alternative
> is to stop buying any more which would, no doubt reduce the value
> of their current holdings but protect them from further losses.<br/>
>
> TWO: They could stay on board. This path would have them falling
> with our economy as we continue to try to print our way out of a
> black hole of debt.
>

Mar 14 12:40 AM

[Spook:]

Question to any expert out there, if China is on a buying spree for commodities and if there is a coming inflation, the commodities will make China richer, question is, what scenario will it take to make China loose more on these commodities values in the future?



> The coming inflation 15 -17% will make China richer with all the
> commodities they are acquiring globally.
>

Mar 14 12:51 AM

[suomimama:]

Too bad we have Pelosi etc ??? What is that supposed to mean? What did Bush etc do about this China debt - other than create and grow it? What would Bush do??? He was like good boy and went to the Olympics!
Seriously - I think also like others that China has more choices than US has - thanks to Bush. Energy, metals - precious and others etc. It sure looks like China is thinking of sinking US and cut their losses...


On Mar 13 03:03 PM wisurvey wrote:

> They do have a strategic asset allocation....and I think we will
> see them more aggressive in African and Aisan commodities (Rio tinto,
> Russian oil, S. Africa gold? Venezuela oil? the list goes on and
> on.....). China has a unique historic opportunity to cover a lot
> economic wealth and resource storage ground in a very short period
> of time (1.25 billion is a LOT of people). Too bad we have Pelozi,
> Dodd, Reed, etc, etc.......

Mar 14 01:41 AM

[dawase@gmai...:]

The obvious answer (which I'm a little surprised wasn't raised in the original article) is that China is an export-driven economy. The US is China's largest export market. HK, Japan, and South Korea are 2-4. Germany is number 5. In 2007, the US imported $233B from China while Germany imported $49B. See the huge gap?

We're still China's most important trading partner by far. It's not arrogance, it's a simple fact. If China ceases support of the US Treasury market, the Yuan will rise against the dollar (and any other currency pegged to the dollar...) What happens to demand for Chinese exports? It gets crushed as Chinese goods become more expensive. Until the Chinese establish a more robust middle class, they will continue to sterilize at least a portion of the trade imbalance.

Tangentially, look at the international fund flows. You'll see that China actually has been buying more treasuries since the crisis started than before because they shifted capital away from equities and GSE paper into Treasuries alone.

All this talk about guarantees? Jawboning... plain and simple. Why? Talk the price down a little bit and at least they'll get a little better yield on their ongoing purchases.

Mar 14 02:35 AM

[polo:]

Default is an option if worse comes to worst. Why would you lend another nation so much money if you don't have to? China should write off half of the debt or keep buying US debt, one way or the other, they will not get 100% money back. Incidentally, holding US treasury and USD for the past year or so turns out to be a good investment. If they put money in any assets, things could be worse. Rich country writes off poor country's debt all the time. It is China's turn as rich country.

Mar 14 03:53 AM

[Sober Realist:]

The following comment from another SA reader on a related topic highlights the ideological problem we have with China:

<< I request the U.S. to maintain its good credit, to honor its promises and to guarantee the safety of China’s assets.>>

No problem, Premier Wen, we will honor our promises... just as you honored your promise to introduce democracy to China, a promise made back when our country opened its borders to your products. You can count on us, pal! (toothy grin and wink)

China is not a democracy, but a dictatorship that has adopted a kind of scorched-earth, totalitarian capitalism capitalism devoid of human rights, environmental regulations, and international transparency/fairness. If you are not part of the CCP and their ideology, then you cannot compete in their market. We had hoped China would become like Korea and Taiwan and slowly adopt democracy when it embraced free market reform in the 1980's. This didn't happen. Since the Tiananmen Square incident in the early 90's, the regime took on a new strategy of "enlightened despotism" in order to rule their masses. This new strategy has created a rich, well-educated urban population inclusive of party members which use the other one billion Chinese migrant workers as a pool of cheap, dispensable labor. The regime has created this huge rift in their society and consolidated power within the urban areas:

"The regime maintains the People's Armed Police, a well-trained and well-equipped anti-riot force of 250,000. In addition, China's secret police are among the most capable in the world and are augmented by a
vast network of informers. And although the Internet may have made control of information more difficult, Chinese censors can still react quickly and thoroughly to end the dissemination of dangerous news.
Since the Tiananmen crackdown, the Chinese government has greatly refined its repressive capabilities. Responding to tens of thousands of riots each year has made Chinese law enforcement the most experienced in the world at crowd control and dispersion. Chinese state security services have applied the tactic of "political
decapitation" to great effect, quickly arresting protest leaders and leaving their followers disorganized, demoralized, and impotent. If worsening economic conditions lead to a potentially explosive political situation, the party will stick to these tried-and-true
practices to ward off any organized movement against the regime."

We have to be careful in our dealings with this country because the brand of capitalism they practice could be a danger to the world.

Mar 14 11:51 AM

[Billy Gee:]

NEWS BULLETIN: U.S. Exports to China down 17.9% but Chinese Exports to the U.S. down only 1.3% in January 2009. Despite the massive financial difficulties of the U.S. China has been able to mitigate its export trade drop to their best "trading partner".

How is China able to do this? Because of increased export credits to their exporters as announced in two recent Chinese programs. Also new manufacturing facilities and new infrastructure is to built with only Chinese made machinery. And then, in the best of mercantile practices, tariffs on imports have been raised -- especially on machinery.

The Chinese Investment Corporation growth will not be impeded by a slowing of its interest rate returns on U.S. Treasuries. This may be a dead-end for U.S. firms who have tried to export to China but not for the Chinese appetite for dollars. They have natural resources to buy all over the world that can be bought with just the interest being thrown off the Treasuries.

Mar 14 02:05 PM

[Moon Kil Woong:]

In the end China can hoard resources rather than cash but what will that do? What's the use of making things no one buys or hoarding resources with no demand? Assets values are relative to demand. China has a billion people. Yet where's the demand?

China ascribes to a paternalistic socialism but then why is their wealth disparity rivaling their rival and closest economic partner the US? If it believes in the rights of the common man over the social elites where are their rights? And who are the social elites. And if the US is so bad why are they allied with them? If capitalism is so bad why are they all bathing in greenbacks?

China's leadership needs to wake up sooner rather than later and realize that the sooner they embrace freedom, capitalism, and democracy the sooner they will not be worrying about a popular uprising every time the economy collapses there.

If they think they are so smart keeping domestic demand down so they can make huge trade deficits they must stop playing monopoly and realize having the money is useless. Money is a means not an end. Governments can coin money to no end. There is no nirvana for a government to hoard it.

The sad fact is that two trillion can go in a heartbeat, especially if it is all used at the same time. It just causes massive inflation on the asset that you spend it on. It does not enrich your people. You enrich your people by affording them prosperity and the freedom to do what they choose with it.

Rather than blaming other countries China should take a good hard look at what it can do to increase wide spectrum prosperity in the country. This is something the US has been urging. Although one may look at it purely abstractly as a balance of trade deficits it not just leads to more balanced trade but leads to higher relative prosperity and political stability. People with a home and assets are much less likely to overthrow the government than ones that labor all day and are close to starvation.

If China thinks that dumping US treasuries is a just retribution against the US and proves its economic might, they will soon see that it will be themselves that will be the ones crying in the end. Rather than proving to its people how great it is by being allowed to dominate its people and run a totalitarian state, they will be shown up as clowns who blew the last 30 years of hard work of their people for naught.

If you think the US will continue to trade the same way as usual if they decide to try to acquire all the commodities in the world they have another thing coming. With no real domestic demand they will find themselves with a lot of expensive metal and no customers. And in a year or two they will find themselves with a lot of very cheap metal and still no customers.

Dumping US Treasuries and ruining trade relations is a mistake you only get to make once. Even though it may hurt the US in inflation temporarily, there are other countries chomping at the bit to be in the envious position the US has offered to China in the hopes they join the world in peaceful, democratic, global capatalism.

It is good for them. It is good for us. That's what WTO is suppose to be about, not economic brinksmanship and talk of the economics of mutual mass distruction.

Mar 14 11:21 PM

[JudeJin:]

in china, there's no free soup line at churchs. china doesn't have many churchs anyway.
but i believe no people are starving yet.

while the soup line at churchs across the USA is already getting longer.

poor people can live on $1/day in china. in USA, $1 can barely fill up the gas tank for you to drive to closest soup line!

Mar 15 11:06 AM

[felixd:]

Lots of folks, Buffett, Marc Faber. Bill Gross have called UST Bonds a giant bubble based upon the assumption that rates must rise as the deluge of more and more supply of UST bonds hit the market. If you do believe that China essentially has no choice and must keep buying more, I would ask the following questions:
1. Can we expect China to INCREASE their holdings of US Treasury bonds to keep pace with the increased supply?

2. What would happen if the Fed started to buy UST bonds? The whole idea of Quantitative Easing is important. Should the Fed start to buy UST, we essentially are just printing money and postponing the day of reckoning while we follow the Zimbabwae economic plan. Might get away with it for a short time, but would we not seriously expect the Chinese to get real nervous and ratchet down the weekly buys of UST the minute they see the Fed starting to QE as Bernanke has suggested?

Mar 15 11:08 AM

[Mike Stathis:]

Maybe if you checked into who I am and bothered to read my previous articles on this site and others you would see why. I already discussed all of this in depth over 2 years ago and I have in part summarized it last year. This is just a small example.

www.marketoracle.co.uk...

See that's the problem with you people. You don't check into track records. I hardly think that just by having a Chinese name, you are qualified to understand the the situation in China relative to the US. You guys need to start figuring things out...the media is NEVER right. They either lack the understanding to select credible experts or else they slant thingsto protect the financial and political agendas of their media company. You take what these media guys say at face value. And that is why you all got blind-sided by the market.

www.marketoracle.co.uk...

www.marketoracle.co.uk...

I've been trying to transform sheep into sophisitcated investors for over 5 years now, but I'm starting to see that this is virtually impossible.

On Mar 13 11:24 AM Mike Stathis wrote:

> Rick, you are so wrong on so many accounts that for me to pick apart
> your article would consume my entire day. This piece is yet another
> example of the journalistic irresponsibility we have suffered in
> America for years.
>
> I would suggest you either leave the economic analysis to experts,
> or else find credible sources that aren't Wall Street or government
> hacks.
>
> For starters, anyone familiar with China knows well about their gov
> bail out. China is being affected like most every other nation but
> China will mount a real recovery in a few years, unlike America.
> China has a real economy, unlike America's Ponzi scheme economy which
> is highly dependent on foreign financiers to keep it afloat. And
> China does not have a $72 trillion deficit in its entitlements programs
> over the next few decades like America.
>
> There are so many issues I really don't have the time to address.
> All I can say is that I would advise you to stick to one topic and
> learn it well. And I would advise against that topic being anything
> to do with the economy. Perhaps you might consider going back to
> writing on the Big 3. Alternatively, you might consider applying
> for a job at CNBC.

Mar 15 11:28 AM

[Sober Realist:]

Why China is unravelling fast:

Imports falling faster than exports and trade surplus increasing - this tells you that domestic demand is falling faster than external demand. The regime has favored a low exchange rate and low interest rates to create an industrial sector that is export driven and capital intensive. With the global economy unwinding, China's industrial economy is now revealed as a bad investment in overcapacity. The 2 big drivers of China's economy have been trade (the export sector) and investment; they are both collapsing.

"Foreign investment in China has fallen for four straight months and slumped by a third in January, according to trade ministry data. More than a third of US companies plan to postpone investments in China this year as the global slump deteriorates, according to a survey by the American Chamber of Commerce in China.
The number of companies who rank China at the top of their list of global investment priorities dropped to the lowest rate since 2004, the Chamber said in its annual business climate report. Direct foreign investment in China plunged 33 per cent to $US7.5 billion ($11.9 billion) in January from a year ago."

"China's complex financial system is tightly controlled by the government. The China Banking Regulatory Commission supervised roughly 8,900 financial institutions in 2007. China has two private banks, but four state-owned banks account for over 50 per cent of total assets. The state directs the allocation of credit, and the big four state-owned banks lend primarily to state-owned enterprises. Numerous foreign banks have opened branches but face burdensome regulations. Foreign participation in capital markets is limited."

Because of the highly regulated, undeveloped, and regime-controlled slant of China's financial system mentioned above, the 4 trillion yuan stimulus package will likely go to the wrong industries and the wrong places, not the ones that are efficient or profitable. This means eventually they will become the banking system's bad debts (massive public-works projects with questionable economic benefits).

China's top-down system has worked well for the regime thus far, but it is now unraveling from the bottom up (20 million Chinese migrant workers last reported unemployed)
www.ireport.com/docs/D...

Will China be able to turn their economy upsidedown. Not in a couple of years? It's a decade long process to do that.

Mar 15 03:37 PM

[User 368437:]

Disclosure: I manage a team of about 150+ employees in central China. I speak, read and write Mandarin fluently. I have lived in Greater China for 8 years and on the mainland for 4+ years.

Frankly, If I were dean of the Darden School of Business, I might ask for Wei Li's resignation. He has grossly misunderstood the current situation in China, and has completely bumbled the assessment of housing in China.

* His employment numbers are out of whack. The talk on the street and in the news is 40 million true unemployed, which places the number around 4%. There is a certain group that are not filing which probably brings it up to 5-6%. The 9.4% urban number is strange -- is this including the roving group of migrant workers that are building the skylines?

* He (she?) says the housing bubble is worse than the US. Yes, value has fallen 40%. Yes, there is a lot of inventory, particularly in Shenzhen and Beijing (around 20 months). What he fails to mention is that since homeowners are required to put down 20% on the first real estate purchase and 30%-40% on the second, they aren't drowning in debt like US homeowners. One of your best investments right now is property in China (more on that later).

* He mentions domestic consumers are scared -- but domestic retail numbers are still quite strong. The shopping malls I visit are bustling with activity.

* Sober Realist mentions that "imports are falling faster than exports... telling us that domestic demand is falling faster than external demand". Well, last time I checked, even domestic end-consumers don't purchase raw materials like iron ore. The China economy purchases raw materials to make into finished goods. I see this as the slowdown in factory activity (domestic + export) which says we still have a while to go before volumes reach end 2007 levels. But my information (JP Morgan) shows an uptick in many raw material purchases in late Q4.

* Make no mistake, China will CONTINUE to purchase less T-bills and move surplus cash into other vehicles -- euro, most likely, for two reasons: 1. They see the US dollar as a weak currency (it is), and 2. After a few years of the Fed printing money and giving it away, the US will have a hellacious inflation problem on their hands.

Look, the bubbling cauldron of discontent just isn't swirling here. I talk to my local managers every day, and most of the blame for the slowdown is directed at the US, not the government in China. I just don't see it. Their lives have improved too much in the last 5-10 years.

I suggest that for those of you who are commenting but have not been to China, you come to see for yourselves.


On Mar 15 03:37 PM Sober Realist wrote:

> Why China is unravelling fast:
>
> Imports falling faster than exports and trade surplus increasing
> - this tells you that domestic demand is falling faster than external
> demand. The regime has favored a low exchange rate and low interest
> rates to create an industrial sector that is export driven and capital
> intensive. With the global economy unwinding, China's industrial
> economy is now revealed as a bad investment in overcapacity. The
> 2 big drivers of China's economy have been trade (the export sector)
> and investment; they are both collapsing.
>
> "Foreign investment in China has fallen for four straight months
> and slumped by a third in January, according to trade ministry data.
> More than a third of US companies plan to postpone investments in
> China this year as the global slump deteriorates, according to a
> survey by the American Chamber of Commerce in China.
> The number of companies who rank China at the top of their list of
> global investment priorities dropped to the lowest rate since 2004,
> the Chamber said in its annual business climate report. Direct foreign
> investment in China plunged 33 per cent to $US7.5 billion ($11.9
> billion) in January from a year ago."
>
> "China's complex financial system is tightly controlled by the government.
> The China Banking Regulatory Commission supervised roughly 8,900
> financial institutions in 2007. China has two private banks, but
> four state-owned banks account for over 50 per cent of total assets.
> The state directs the allocation of credit, and the big four state-owned
> banks lend primarily to state-owned enterprises. Numerous foreign
> banks have opened branches but face burdensome regulations. Foreign
> participation in capital markets is limited."
>
> Because of the highly regulated, undeveloped, and regime-controlled
> slant of China's financial system mentioned above, the 4 trillion
> yuan stimulus package will likely go to the wrong industries and
> the wrong places, not the ones that are efficient or profitable.
> This means eventually they will become the banking system's bad debts
> (massive public-works projects with questionable economic benefits).
>
>
> China's top-down system has worked well for the regime thus far,
> but it is now unraveling from the bottom up (20 million Chinese migrant
> workers last reported unemployed)
> www.ireport.com/docs/D...
>
> Will China be able to turn their economy upsidedown. Not in a couple
> of years? It's a decade long process to do that.
>

Mar 16 04:55 AM

[Bad Dog:]

China will start doing what it needs to do. It is signaling that it will start pouring resources into its internal economy, modernizing and building infrastructure on a huge scale. It will use up much of its foreign reserves in doing this. But the transformation will have China emerge as a country that trades with itself a lot more than it trades with other countries, just as the US does. The problems that China will face are (a) increasing provincial power relative to the central authorities, (b) building independent entities that regulate internal trade, (c) building internal equity investment mechanisms, and (d) establishing an independent mechanism for civil law practice. So China needs to mature its economy beyond the old export or die model, but in doing so it will have to build a lot of things it doesn't have now. Quite a conundrum.

Mar 16 03:31 PM

[Sober Realist:]

Bad Dog,
More on the points you made:
Private Business Sidelined by China's Stimulus
By Liu Zhaoqiong, Xi Si, Wei Liming, Li Ping TEXT:
Published: 2009-03-16 From cover, issue no.409, March 9, 2009
Translated by Zhang Junting

Chinese private businesses have complained of a lack of access to projects and loans related to the four-trillion-yuan stimulus package introduced some four months ago.

They have blamed their state-owned counterparts for unfair competition, carving up nearly the entire stimulus pie and soaking up new bank loans.

"Government investments have been mostly circulating within large state-owned companies.... Once they get projects and funding, they source for all supplies, down to the tiniest spare parts, within their own system and interest groups.

"It is impossible for the private sector to penetrate these walls," said Bao Yujun, Chairman of the China Private Economy Research Center and former vice-president of the Chinese Federation of Chamber of Commerce.

Funding channels also favored state-owned firms, which commercial banks deemed as low-risk clients who enjoyed government backing and economies of scale.

Open data revealed that in January alone, of the 1.62 trillion yuan new loans issued, some 90% had flowed to government projects won by state-owned companies through tender process.

Step-Child of the Chinese Economy
In recent years, private businesses have contributed up to 65% of China's GDP, created more than 80% of new jobs, filed 65% of all patents for new inventions, and produced more than 80% of new products.

But the private sector has been squeezed since the first quarter of last year as the government tightened credit controls to curb inflationary pressure. And after the financial crisis, a perfect storm of fallen exports and domestic demand, an investment pull-out, and deflationary pressure threatened their cash flows even further.

Despite that the Chinese government kick-started the stimulus package last November and promised to inject more new loans into the market this year, the survival outlook of private businesses remained gloomy.

Bao, who recently did a research on the impact of stimulus measures in Zhejiang province - the cradle of China's private capital, found that private firms were being sidelined, as the playing field was not even.

Not only the state-owned firms had an upper hand in bidding stimulus-related projects, they also held the power to decide which downstream businesses to patronage for supplies and sub-contracting jobs....
www.eeo.com.cn/ens/Ind...

Mar 17 08:11 PM