The US debt negotiation ceilings are going to the wire. China, the biggest holder of Treasury debt, is watching on helplessly as it gets taken to the financial cleaners.
The political drama in Washington over raising the United States’ federal debt ceiling has grabbed the world’s attention. While the main protagonists in the play are the Republicans and Democrats, one spectator anxiously awaiting the outcome of the bitter partisan struggle is undoubtedly China, the largest single holder of US Treasury debt (roughly $1.1 trillion). In a nightmarish scenario of an American debt default, the prices of the Treasury bonds China has accumulated are bound to decline significantly. Even if the US government decides to pay the interest on outstanding bonds before honouring its other obligations, the financial markets will likely demand higher interest rates (especially if the US credit rating is downgraded), thus causing the prices of US bonds to fall. Because about 60 percent of China’s $3.2 trillion in foreign exchange reserves consists of dollar-denominated assets (in addition to $1.1 trillion Treasury bonds, China has bought hundreds of billions of dollars in mortgage-backed securities), the paper losses from the price declines of dollar-denominated bonds, and the depreciation of the dollar itself, will likely be in at least the tens of billions of dollars.
To Beijing’s credit, the Chinese government has kept relative silence so far. Except for vague calls for the United States to protect its investors, no Chinese officials have said anything that could be construed as a threat of dumping US Treasury debt if Congress fails to raise the debt ceiling. The official press, including tabloids known for nationalist rhetoric (such as the Global Times), has been restrained in its coverage on the issue. To be sure, China has maintained an ultra-low profile out of self-interest. It will only hurt itself more if it raises alarm about a possible US default and spooks the financial markets.
China’s $2 trillion dilemma is well-known. Since 1994, China has kept its currency, the renminbi, effectively pegged to the dollar. While initially this policy worked well in stimulating Chinese exports and stabilizing domestic prices, Beijing allowed the peg to continue for too long, mainly to maintain an undervalued currency in gaining a competitive advantage in foreign trade. By the middle of the last decade, the undervaluation of the renminbi became a hot bilateral issue between the United States and China as America’s bilateral trade deficits with China soared.
Under pressure from Washington, Beijing reluctantly began to raise the value of its currency in mid-2006 (when its total foreign exchange reserves totalled just under $1 trillion). China’s revaluation process was disrupted by the global economic crisis in 2008. Fearful that its growth could falter if revaluation made Chinese exports less competitive, the Chinese government suspended raising the value of the renminbi in late 2008. As a result, Chinese current account surpluses continued to balloon. The numbers are astounding. In July 2009, China reported $2.2 trillion in forex reserves, more than double the amount in 2006. Today, two years later, China’s forex reserves have reached $3.2 trillion.
Photo Credit: Flickr / SqueakyMarmot
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RESISTANCE IS FUTILE
dude forgot to mention the "American people" are directly or indirectly holding 10 trillion of those bonds too
Pete
According to Zero Hedge, countries outside of the U.S. dumped 74 billion dollars in U.S. Treasuries, most of it over the weekend:
“Over the weekend, we observed the perplexing sell off of $56 billion in US Treasurys courtesy of weekly disclosure in the Fed’s custodial account (source: H.4.1) and speculated if this may be due to an asset rotation, under duress or otherwise, out of bonds and into stocks, to prevent the collapse of the global ponzi (because when the BRICs tell the IMF to boost its bailout capacity you know it is global). We also proposed a far simpler theory: “the dreaded D-day in which foreign official and private investors finally start offloading their $2.7 trillion in Treasurys with impunity (although not with the element of surprise – China has made it abundantly clear it will sell its Treasury holdings, the only question is when), has finally arrived.” In hindsight the Occam’s Razor should have been applied. Little did we know 5 short days ago just how violent the reaction by China would be (both post and pre-facto) to the Senate decision to propose a law for all out trade warfare with China. Now we know – in the week ended October 12, a further $17.7 billion was “removed” from the Fed’s custodial Treasury account, meaning that someone, somewhere is very displeased with US paper, and, far more importantly, what it represents, and wants to make their displeasure heard loud and clear. (Source)
Undoubtedly, the Chinese and other countries have recently discovered that Italy and Greece, with smaller debt to income ratios than the United States, are less riskier and carry a higher rate of return. This is because, unlike the US, the Rothschild/Rockefeller bond rating agencies have trashed their country’s debt ratings, forcing them to pay a much higher interest rate than U.S. Treasuries. Hey, if you take the risk, you might as well earn the reward! http://www.moneyteachers.org/Foreigners+Dump+Treasuries.htm
Norm
Firstly, while China is the largest *foreign* holder of treasuries it is not the largest holder. The largest holder is currently the Fed.
As for being taken to the financial cleaners, …seriously??? Has the author noticed the performance of bonds during the period that China has accumulated these large holdings in treasuries?
At least the author acknowledges that this position, which he calls a problem, but is the kind of problem I’d love to have, is of China’s own making by sticking to a currency peg that ensured massive trade surpluses accumulated.
Mostly this article displays a misunderstanding of Americas deficit problem and of its monetary system.
Matthew K. Seibert
Well I think that this is a situation where China has learned that investing in an unstable economy has it’s economic consequences. And I have been tossing around a solution.
The American economy has been growing at a sluggish pace, and this is largely due to the wholesale destruction of it’s manufacturing industry. According to the Council on Foreign Relations Working Paper, “The Evolving Structure
of the American Economy and the Employment Challenge,” the United States needs to add exports and balance it’s trade deficit.
So I argue for exactly that. Let’s build a mutually beneficial relationship between China and the United States, where more American goods or services are purchased, thus balancing the trade deficit. I’m advocating for more Chinese investment in American infrastructure, American manufacturing and the American service industry.
A key opportunity for growth would be low interest or no interest micro-loans to small business entrepreneurs in the United States. Another opportunity would be getting involved in public private partnerships between Chinese businesses and American projects. We can also integrate supply chains between American manufacturing and Chinese manufacturing so that more work can be done on the American side of the business to business chain.
It’s a simple philosophy, “give a little to get a little.” If you put Americans back to work, that puts more money in the coffers of the government. And that’s more money to pay back the interest on bonds.
In fact, this situation has led me to a new formulation of foreign policy. It is no longer a zero sum game. But rather, one in which the victor builds mutually symbiotic relationships with all players. So I look forward to the future. Hopefully, it will be a more peaceful, and more fruitful time.
ozivan
@Matthew K.Seibert. You’re a man of peace !! Have questions for you though.
What has happened to civil aviation side of Boeing ? A decade ago, they were the undisputed top exporter of commercial airplanes, but now the Airbuses seem to be overtaking them. Must have caused the loss of thousands of jobs.
And then, why aren’t the Americans massively developing the medical appliances, specialised pharmaceuticals, etc types of industries that create much employment, yet can withstand high US labor costs? These are items that China (and the world) wants to import in the future to improve the lives of their people. They are so many areas of innovation that US excels, which will be good exports to China, if US can produce them in massive economies of scale, rather than be known only for producing the best killing machines.
Anyway, it’s good to read your peaceful comments, for they bring goodwill to the world. Thank you.
Matthew K. Seibert
The major drivers of the American economy are financiers. These financiers can gain more profits from money markets and risky investment practices than from investing in the American economy. In essence, our investment class no longer invests in the United States.
Now I don’t blame them, because our system is in a sense, broken. Our publicly traded corporations are only tied to seeking profit–seeking higher returns each quarter. This is a short-term mentality. It does not encourage re-investment in the existing system, and therefore, our manufacturing industry is left to become obsolete and expensive. A solution to this problem would be to re-tier the system so that innovation and investment are placed ahead of pure profit. And an ideal example of this system is the German economy.
However, the Asian markets can learn from this mistake. By putting long term strategies for growth and investment ahead of the profit motive, businesses end up becoming more successful in the long run. Thus, I appeal to the Asian markets to come into the United States, and rebuild our economy using the long-term strategies that the United States investor class has abandoned.
a_candian_observer
@Matthew K. Seibert: Respectfully, I agree with your thoughts, though I may add, that the model can only work if the 2 parties respect their signed agreements, IPs, etc…
The question is, will the chinese be up to the task on this mutual respect for other’s ideas. Perhaps later but judging by what has happened up to now, I doubt this model will be fruitful.
Matthew K. Seibert
I understand your point. I think the incentive is still on the horizon. That is why us, forward-thinking individuals have diagnosed the problem early. Because it will only be so long until the United States population can no longer afford goods produced in China. And we won’t be able to pay back the bonds. So in order to avoid that future, re-investment in symbiotic opportunities seems like a much better course of action.
Clove
It looks to me that treasuries are near yearly highs and a conservative estimate would put 95% of all US treasury assets that China owns in the money. If that’s taken to the cleaners, sign me up.