Acclaimed Harvard economist and historian Niall Ferguson has long maintained that the codependent construct of "Chimerica" (PDF) is unsustainable - that the thrifty, export-driven economy of China and the overleveraged, consumer-oriented, import-dependent service economy of America ultimately make for strange bedfellows. At some point, he surmised, the rising power of China will become a threat, and the intertwined arrangement of the top two global powers will begin to unravel.
Critics claimed the inevitability of that transition was nonsense, drawing parallels to the "mutually assured destruction" paradigm of the Cold War. But what if the Chinese credit crunch, and the sudden rise in US interest rates that gripped the headlines with an alarming dose of unseasonably high market volatility recently are a smoke signal of bigger tensions to come?
The Devil is in the Details, The Writing is on the Wall
Every Thursday, the US Federal Reserve releases its most up-to-date details on its balance sheet holdings. We typically look for changes in the US treasuries and mortgage backed securities components - the key ingredients of QE3 - to track the pace of Fed's estimated $85B aggregate monthly increase. This week's report contained quite a revelation. The balance of US treasuries held by foreign central banks, typically little changed or gradually increasing, actually fell by over 1% from $2.97T to $2.93T. By contrast, Fed holdings of Treasuries rose from $1.92T to $1.93T.
1. Foreign central banks hold 50% more of US government debt than the Federal Reserve.
2. This week, while pundits debated just how much closer the marginal change in the last Federal Open Market Committee (FOMC) policy statement brought us to tapering QE3, foreign central banks SOLD 4 times as much US debt as the had Fed bought!
Looking closer into historic data, $2.93T marks the lowest level of US debt held by foreign central banks in 5 months.
Yes, the Federal Reserve does not break out the foreign holdings by entity, but considering China holds the biggest slice of the total (over $1.25T, according to the latest available TIC data), liquidity issues of its overleveraged banking system make Beijing the prime suspect in dumping some its holdings. Hence the higher interest rates, the bond market turmoil, and what Niall Ferguson might consider the canary in the coalmine of the great Chimerica divorce.
One week does not a trend make. Monetary authorities in China may well decide the political message to the overextended lenders has been made and July will the see return to business as usual.
In other words, neither of the partners is calling their divorce lawyer just yet. Perhaps one of them is merely locked out of the bedroom following an extra-late night with his non-married buddies at the local bar, and spending the night on the couch.
But suddenly, the weekly balance sheet data takes on more meaning and the bigger question in the debate over the impact of Fed exit after months of extraordinary measures becomes not how soon the Federal Reserve starts to taper off its buying of US debt, but rather, can China's interest in maintaining its US Treasury holding, let alone its appetite for more buying, be sustained.