Troubles at the People's Bank of China

I have a good friend who has been in the business for many years who always has a good story to tell. Many years ago he worked for a now defunct bond house with the name Berkeley Capital. We were in some financial district watering hole and someone else in the group asked my friend how much capital Berkely Capital had.  My friend, always an Irish wit, responded with a question of his own. He inquired of the gentleman who had questioned him if he had ever been to Lake Hiawatha , New Jersey. The original questioner replied in the negative and and asked why that was important. My friend responded with the answer that there is no lake in Lake Hiawatha, New Jersey.

I thought of that humorous story after reading the following article in the New York Times this morning.

The New York Times today carries a very informative article on the People’s Bank of China.  As the author puts it, they are in a bind. The central bank owns $1 trillion of US government bond but operates on a wing and a prayer with just $3.5 billion in capital. Thank the Lord that they are not deleveraging. 

The article notes that the central bank might borow or seek a capital infusion fron the Finance Ministry. In so doing they might cede some independence and the action might also result in a slower pace of increase for the yuan versus the dollar.

The $1trillion portfolio has eroded on a mark to market basis as the yuan has increased in value and that has rankled some in that country.

Anyway, it is an important story with a host of implications for the markets here. 

Comments

[poet1:]

so, what are the host of implications for markets here, please continue..

2008 Sep 05 11:57 AM

[Larry House:]

Thanks, John. I echo poet1. One implication is that China may slow or stop purchases of our debt. Where will we be then? Maybe that constriction is what is needed to get our government to stop the spending binge. We may think things are bad now, but there are some big shoes out there that can drop, and it is going to be painful!

2008 Sep 05 12:04 PM

[otbricki:]

If China tries to get rid of their bucks what are they going to get in return that is better? Commodities? Some other currency? Equities? LOL.

2008 Sep 05 12:45 PM

[Chris B:]

I agree with LarryH. Whether this will be a slow process or a shockingly fast one is anybody's guess, but I don't think anyone believes this massive goods-for-debt trade can go on forever. The currency of a country that produces almost nothing and builds up massive debts will decline - it's practically a law of economics.

The problem is, people have been pointing that out since, oh, about the early 1980's when we began the de-industrialization process. Thus the naysayers have lost credibility in the eyes of most people. Of course, the same happened to the people who were worried about tech valuations in 1996 or home prices in 2003.

Seeing an impending crash during a bubble will get you called an idiot - until you profit from it. However, I have no idea how to profit, or even break even, from the impending long term decline of the dollar and US living standards. I also have no idea whether it will start next year, 10 years out, or 20 years out.

2008 Sep 05 01:00 PM

[fatcat:]

Spot on,Chris..how will anyone profit with the dislocations coming for almost all businesses and it will spread around the world.

Almost a sure recipe for WWIII....

2008 Sep 05 02:39 PM

[YY:]

Looks like the People's Bank of China is holding over $1 trillion US dollar, that is almost certain to devaluate in the future. How to better use of the money really test their abilities. One idea I think is that they should invest in global commodity equities. After all, they are REAL assets versus the US PAPER!

2008 Sep 05 05:14 PM

[Urbane Gori...:]

A prior article noted that China is dumping FRE and FNM and is not sure where to invest right now..... But to answer the above posts, if you click on the link he indicates, you can read the article ... For those that can't navigate away for some reason, this is the gist of the article;

----------------------...
China’s central bank is in a bind.
Skip to next paragraph
Enlarge This Image
Associated Press

Dollar and yuan currency at a bank in China. China’s central bank has accumulated about $1 trillion in United States debt.
Multimedia
The High Cost of Intervening in Currency MarketsGraphic
The High Cost of Intervening in Currency Markets
Add to Portfolio

* Fannie Mae
* Freddie Mac

Go to your Portfolio »

It has been on a buying binge in the United States over the last seven years, snapping up roughly $1 trillion worth of Treasury bonds and mortgage-backed debt issued by Fannie Mae and Freddie Mac.

Those investments have been declining sharply in value when converted from dollars into the strong yuan, casting a spotlight on the central bank’s tiny capital base. The bank’s capital, just $3.2 billion, has not grown during the buying spree, despite private warnings from the International Monetary Fund.

Now the central bank needs an infusion of capital. Central banks can, of course, print more money, but that would stoke inflation. Instead, the People’s Bank of China has begun discussions with the finance ministry on ways to shore up its capital, said three people familiar with the discussions who insisted on anonymity because the subject is delicate in China.
----------------------...

jegan ;-)

2008 Sep 05 07:45 PM

[chinesezodi...:]

Chris B-- you know 'it' has already started actually... the US $ was at ~1.6 to the Euro recently, right? The Fanny and Freddy bailout this weekend can have no other effect than to be be quite inflationary, probably massively so....
But as Bill Gross (and this article) points out, there are fewer and fewer 'entities' left to step in as time goes by, because they are already underwater on what they bought months ago. The US government is going to, in effect, severely dilute our currency to (try and) get things moving again. This happens just as people were seeing that deflation was the real enemy... who knows what happens, or where the heck to put money!

2008 Sep 06 04:38 AM

[fran:]

they[china] wouldn't use our debt to buy our banking giants, would they? if the treasury saves the giants, would that make our trillions in debt worth less to china? would they sell our trillions now at discount if they could find things of greater value for their future?

i wouldn't want to be in our shoes.

2008 Sep 06 02:36 PM