Michael Pettis

Shorting the Long Bond: The Obama Solution Meets China

Although I agree with some of your conclusions, I think you make two very common mistakes. The first is the assumption that China can use its foreign reserves to shore up domestic investment. It cannot. Reserves can only be used for spending abroad, and if China tried to convert reserves into RMB it would cause a massive surge in the value of the RMB that would destroy its export sector. Given the importance of the export sector to China, this will almost certainly not happen. The PBoC, by the way, has tried to point this out many times but most people continue to confuse foreign reserves with domestic wealth.

Second you say "Thus, while we stand on the verge of a huge increase in US Treasury offerings, the largest buyer has left the trading room." I am not sure how you came to that conclusion. As long as China runs, or wants to run, a trade surplus with the US (and August and September were the two highest surplus months in history), it has no choice but to buy US dollars directly or indirectly. If it stops, its trade surplus with the US disappears. Again, given the importance of its exports to the US, it is pretty unlikely that it will want to do so – on the contrary they are now doing everything they can to shore up exports. In fact while China's reserves continue to surge, there is some circumstantial evidence that they have increased the dollar share of total reserves.