Why We Have to Keep China Happy 23 comments
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China bought less than a sixth of the Treasuries issued in the 12 months through March. Less than two years ago, by contrast, Chinese purchases of Treasuries, which included purchases in the secondary market as well as newly issued securities, briefly exceeded the entire borrowing needs of the United States.
Financial statistics released by both countries in recent days show that China paradoxically stepped up its lending to the American government over the winter even as it virtually stopped putting fresh money into dollars.
This combination is possible because China has been exchanging one dollar-denominated asset for another — selling the debt of government-sponsored enterprises like Fannie Mae and Freddie Mac in a hurry to buy Treasuries. While this has been clear for months, new data shows that China is also trading long-term Treasuries for short-term notes, highlighting Beijing’s concerns that inflation will erode the dollar’s value in the long run as America amasses record debt.
So China’s rising purchases of Treasuries do not represent the confident bet on America’s future that they might seem to be on the surface. For instance, China does not appear to be dumping euros or yen to buy Treasuries, economists said.
- “China Grows More Picky About Debt”, The New York Times, B1, May 21
A couple of other interesting excerpts from the article:
China now earns more than $50 billion a year in interest from the United States, [Brad] Setser at the Council on Foreign Relations calculated…
This spring China has also been stepping up its purchases of commodities, which are usually bought in dollars. Iron ore has been piling up on Chinese docks, government stockpiles of crude oil and grain are being expanded and stockpiles are being started for products like gasoline, diesel and sugar.
After six years of silence, China unexpectedly disclosed last month that it had been gradually buying gold from domestic producers. The country’s reserves had climbed from 600 tons in 2003 to 1,054 tons, worth $31.8 billion at prices late Wednesday.
The disclosure, which produced a frisson of excitement in gold markets, may have been aimed at reassuring a domestic audience that the Chinese government was not putting all the nation’s savings into American dollars. But the actual investment was tiny compared with China’s foreign exchange reserves — and showed that China was accumulating gold at a much slower rate than foreign currency.
A person in periodic contact with China’s central bank, who insisted on anonymity to preserve his access, said that a Chinese central banker complained to him last year that “we have so much money and there’s so little gold, we can’t buy much without driving up the price.”
I recently wrote about this subject in a Client Note:
We have lent a huge amount of money to the U.S., so of course we are concerned about the safety of our assets. Frankly speaking, I do have some worries.
- Chinese Premier Wen Jiabao.
We hate you guys. Once you start issuing $1 trillion to $2 trillion…. We know the dollar is going to depreciate.”
- A Chinese official in an interview with the Financial Times last month.
The other big story that caught my attention last week: Some strong words out of China about its massive US dollar, agency and treasury holdings. For those of you who don’t know, massive imbalances have grown in the global economy over the last decade. Many of the goods we buy here in the United States are made in China and Asia. On the other hand, we don’t sell nearly as much to Asia as we buy from them. That results in massive current account deficits here and surpluses over there.
Ultimately, that means they have a huge excess of dollars that they must either hold or re-invest in US assets. This has been going on for many years and as a result China and the rest of Asia have accumulated massive holdings of US assets, mostly treasuries. For example, according to the US Treasury, China held $727.4 billion in US treasuries as of December and Japan only slightly less.
As Fed Chairman Ben Bernanke told 60 Minutes this evening, in response to the financial crisis the Federal Reserve has essentially been printing money (”Ben Bernanke’s Greatest Challenge", 60 Minutes, Sunday March 15, 2009: This dilutes the value of the dollar in foreign exchange markets and destroys the value of foreign investors’ dollar denominated holdings. China is none too happy about this and Premier Jiabao’s comments were a shot across the bow.
There is real risk here because China and the rest of Asia’s massive US holdings give them a measure of power over our economy. Were China to start to unload its dollar and treasury holdings, that would send the dollar down in foreign exchange markets and the fall in treasury prices would result in an increase in interest rates. The falling dollar would make imported goods more expensive meaning higher prices for U.S. consumers. Rising interest rates would hurt all borrowers and increase the strain on our debt-laden economy.
This is a serious, big picture, geopolitical issue. I know it’s hard to get your mind around a big, abstract issue like this, but this is something every investor should be aware of. We must keep China and the rest of Asia happy because of the economic power they now hold over us due to their enormous lending to the US government.
Richard Duncan has written a superb book on the subject: The Dollar Crisis: Causes, Consequences, Cures (Updated June 2005) for anyone who is interested. In fact, it was my good friend bringing this fascinating issue to my attention towards the end of 2004 that catalyzed my interest in the economy and financial markets and ultimately resulted in my leaving the Phd Philosophy program at UC Davis and starting Top Gun.
- “Top Gun FP Client Note: You’ll Never Catch The Bottom”, March 15
Also see: “Is This A Dollar Crisis?”, Top Gun FP, November 7, 2007
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Don Hamilton
Don Hamilton
And by the way user 357705, China doesn't own the US...yet.
In 1944 Bretton Woods gave us the gold-dollar standard so that everyone's national currency could be converted into US$ that were backed by gold at a fixed price ($35 per ounce, if memory serves). In 1971 when Nixon found the gold standard was restraining his ability to print enough US$ to finance government expenditures (Vietnam) he ended the dollar's tie to gold and the world no longer had a formal currency exchange regime, though the US$ continued to be used as the world's 'hard money'.
With the recent attempts by the Fed and Washington to inflate the US$ money supply China is worried that the dollar, which is the 'gold' they are using to back up their yuan, is losing value. If the value of the yuan is linked to the value of the dollar vis-a-vis all other currencies, and if the dollar declines, then Chinese purchasing power declines. It will cost more yuan to buy the same basket of imported goods and China will experience price inflation. China will 'import inflation' via the yuan's link to the US$.
This is why China is advocating a new international exchange currency based on a basket of currencies rather than just the US$. They are worried that they are losing too much money (purchasing power) under the current US$ regime.
The Chinese clearly do not believe that their yuan has 'decoupled' from the US$. That is, they seem to not believe that the yuan can stand on its own, that their money will not be accepted as a currency of international exchange if it is not backed up by holdings of 'hard' assets like US$ or gold. China has recently made some bilateral currency exchange deals (Brazil, and Argentina I think) where the 2 countries agree to buy and sell in each other's currency rather than converting all transactions to US$. But apparently China shares the belief of goldbugs and other 'hard currency' advocates that the world needs a common, stable basis for everyone's money. If the US has proved too profligate to provide the world with a stable currency, then they want some other regime in place that will be stable.
With the first black American President and a female Secretary of State, who time and again champion the plight of women worldwide, you would think someone would speak up for the hundreds of millions of poor people that are being raped, beaten and murdered on a daily basis.
Apparently, the USA is more interested in keeping the Communist Status Quo satisfied. If you want to know what is really happening, read CHINA HOUSE, available on Amazon.com, to get "the rest of the story."
On May 24 10:16 AM Don Hamilton wrote:
> Who are the Chinese going to sell their US treasuries too? They own
> 700 billion dollars of our IOUs, mostly in the form of US treasuries
> which earn interest - are they going to sell them on the market for
> US IOUs which earn nothing? I don't think so! They could start buying
> our commodities or manufactured goods which be a much better deal
> for both countries. This would put Americans back to work and allow
> us to buy more Chinese goods. We are trading partners which should
> benefit both countries.
>
> Don Hamilton
On May 24 12:44 PM MeleeTrader wrote:
> The Chinese could start to buy pecentages in US companies with the
> US currencies. How about 20% ownershio in every US company that
> wants to do biz in china.
On May 24 10:16 AM Don Hamilton wrote:
> Who are the Chinese going to sell their US treasuries too? They own
> 700 billion dollars of our IOUs, mostly in the form of US treasuries
> which earn interest - are they going to sell them on the market for
> US IOUs which earn nothing? I don't think so! They could start buying
> our commodities or manufactured goods which be a much better deal
> for both countries. This would put Americans back to work and allow
> us to buy more Chinese goods. We are trading partners which should
> benefit both countries.
>
> Don Hamilton
HaHa what a world.
Nobody want to kill "the goose..." but they sure as hell might be up for plucking some feathers.
jb
On May 24 03:53 PM jambo wrote:
> I see it as a one hand washing the other scenario. Any massive assault
> against the dollar would serve to equally undermine their economies
> as well, no?
> Nobody want to kill "the goose..." but they sure as hell might be
> up for plucking some feathers.
> jb
On May 24 01:05 PM fran wrote:
> they need not sell to do USA great damage. they just need to NOT
> BUY.
On May 24 05:41 PM Don Hamilton wrote:
> So what what are they going to do with all the IOUs (dollars) that
> we give them in exchange for the goods we buy from them?
From your opening remarks there seem to be the suggestion that China was completely blindsided by the economic turn of events and credit collapse. They were huge buyers of Treasuries at a time when they should have been using caution. How is that possible with so many Chinese watching our every move and some of the savviest thinkers in the West warning over two years ago about what was going to take place.
Were the Chinese lulled into a false sense of security like so many other investors here at home. Surely they were looking at the data too and assessing the risks. Makes you wonder.
If they weren't already you can be sure they are reading "Seeking Alpha" now and taking plenty of notes on how the West really functions.
On May 24th Greg Feirman wrote:
> China bought less than a sixth of the Treasuries issued in the 12 >months through March. Less than two years ago, by contrast, >Chinese purchases of Treasuries, which included purchases in the >secondary market as well as newly issued securities, briefly >exceeded the entire borrowing needs of the United States.