Chinese Bond Sales Raise Concern
25/02/2010 3:15:03 PM
By Greg Peel
On Tuesday night the US Treasury auctioned US$44bn of two-year notes. Last night it auctioned US$42bn of five-year notes. Tonight it will auction US$32bn of seven-year notes. Commentators have long ago stopped noting that such sales amounts often break previous records.
Last week the US Treasury auctioned US$40bn of three-year notes, US$25bn of ten-years and US$16bn of thirty-years. Indeed, every month the US Treasury auctions off billions upon billions in bonds, notes, and shorter dated bills. This is the mechanism by which the US funds its massive fiscal and current account deficits. America goes cap in hand to the world, seeking support for the maintenance of a lifestyle to which America has become accustomed. Since around 1975, net US debt has skyrocketed, far, far beyond the growth rate of US household income. This is not debt for which the principal is ever going to be returned – ever. Only interest payments will be forthcoming.
And the world laps it up. Or at least, the world has been lapping it up so far. Everyone across the globe wants to sell goods and services into the biggest consumer market on the planet, and the only way this can be done is to lend those consumers the money to spend. It's a vicious circle which cannot be broken because a point of no return was passed decades ago. Cut off America, and you cut off your own export receipts and your own lifestyle.
Obviously the whole system is no better than a house of cards, oras others have suggested, the world's biggest Ponzi scheme. And the house nearly collapsed in 2008, but given the vicious circle meant everyone would be a loser, the simple solution was to print enough “paper” money to counter the deflationary forces of economic recession. And here we are.
The GFC has brought into focus the need to address the “global imbalance” which in simple terms can be defined as China, Germany and Japan selling goods to the US on credit while saving all the receipts. Those receipts have to be parked somewhere safe, and what better safe haven is than in debt issued by the government of the economy which is still bigger than the other three put together? And that's before we talk about who has the most bombs.
So keen has the world, and the domestic US investment market, to park its funds in this safe haven that recently US one-month Treasury bills fell to a negative nominal yield. That means even ignoring inflation, investors are paying America for the right to lend America money. How will the globe ever be rebalanced when this sort of attitude prevails?
One alternative which was previously favoured by the creditor nations post-GFC was to start diversifying out of US-only investments and to spread funds around into other sufficiently safe havens including IMF bonds, euro-denominated assets and gold. Gold provides no interest payment, nevertheless, and is volatile in price. There is no eurozone bond, and now Greece has thrown a spanner in the works of any euro-denominated assets being some sort of safe haven. IMF bonds are fine but limited, and they still have a 40% US dollar weighting.
So over there's a rock, and over there's a hard place. And the conundrum is made even rockier and harder by the fact that any full-scale withdrawal of credit to the US would result in existing investments being trashed in value. Damned if you do...
Another major problem creating global imbalance is China's pegged currency. While Japan and Germany helped America into its endless credit cycle mess, China's non-floating currency opened up a whole new world of artificial spending opportunity for Americans. There has been no one more vocal in its desires to diversify away from its massive US investments than China, but to do so is to risk both wiping out the value of its investments to date and derailing Chinese economic growth.
But Chinese economic growth would also be derailed if the renminbi was allowed to float, because suddenly China's US investments would be worth far less in its own currency and Americans would no longer find Chinese goods “cheap”. Post-GFC, China has not been selling as much to the US as previously so it is not buying quite the same amount of US debt, but China still has to buy at least some US debt. Euro investments are now off the cards, and China produces enough of its own gold, it would seem. And it has already loaded up on what IMF bonds are available.
But China has more recently been exploiting a different way to diversify its investments while still preventing a US dollar collapse, and that is simply to cut out the middle man and buy US dollar-denominated commodities – iron ore, copper, you name it. And China has been cutting out further middle men by actually buying into the companies that produce those commodities, which it has been doing across the length and breadth of the earth including in Australia.
There is only so much iron ore and copper etc China can buy nevertheless, particularly at a time when the US and West in general are no longer spending like mad on Chinese manufactured goods. Another earlier form of diversification was for China to buy not only US Treasury bonds, but US state and municipal bonds as well.
But in the latter case, Greece changed the picture, it is believed. China instructed its state investment body to withdraw from lower-rated debt and stick only to higher rated Treasury debt for fear that the building European crisis would serve to blow out credit spreads on less all reliable economies, including those of US states and municipalities. [See China Battening Down The Hatches].
Which means China is once again buying only US Treasuries. This should be some sort of comfort for America, except for one problem. It would appear China, and the world, is beginning to see the US as too much of a risk out to any length of time. In the aforementioned Treasury auctions, while foreign central bank demand for up to two-year US debt remains strong, demand any further out is waning, and waning fast. If America cannot find backers to support its printed money out to time – time for which the US deficit is expected to go on and on – then the next risk is hyperinflation, Zimbabwe-style.
The world has become tired and nervous of buying more and more longer-dated US debt. The more it buys, the more becomes available. Foreign participation rates in longer-date US Treasury auctions has been dropping alarmingly. Greece is not the only problem nation. All the world has managed to do post-GFC is take all the debt burden out of the private sector and re-establish it in the public sector. We no longer fear investment banks going down, we fear countries going down.
Another reason why China in particular would want to re-concentrate its US investments into short-date debt is because very soon China will revalue its currency by an expected 5% in order to ease off its runaway economy. This immediately has the effect of devaluing US investments, but the shorter the date the lesser the valuation impact. The same goes for wider credit spread debt such as state and municipal debt.
But there is more to the story. China has clearly been selling US bonds in recent months, rather than just not buying them. Is this just part of switching into shorter dates or is there a more insidious agenda behind the sales?
China is now in a position of considerable global power. The US may still be the world's undisputed superpower but China holds the kryptonite. For if China was to call in its US marker (sell all its US bonds) the US economy would collapse. Mind you, the result would be largely internecine, given China's surplus and export market would be wiped out, but China is not beyond flexing a bit of muscle and letting the US know just who is holding the cards here (pardon the mixed metaphor).
And China has two areas of ongoing frustration. They're called Taiwan and Tibet, and from an imperial perspective China believes it holds unalienable rights over those “countries”. China gets very upset when world leaders meet with China's “enemy” in the Dalai Lama, which President Obama did last week, and was previously furious when America agreed to sell arms to Taiwan.
On the Taiwanese front, China holds considerable power. As soon as arms contracts were announced between Taiwan and the likes of Boeing, for example, China threatened to stop buying Boeing aircraft. Given over 50% of China's airline fleet is made up of Boeing planes, and the total is rapidly growing, Boeing found itself with a difficult decision to make.
Meetings with the Dalai Lama have not elicited quite such a direct response, but suffice to say the London Telegraph has pointed out that the day Obama met with the Tibetan leader the (Communist) China Daily praised moves by the Chinese authorities to “slash” holdings of US debt.
And we won't even begin to speculate on Google's problems, general computer hacking and intellectual property theft.
What is of concern here is that a political rift is building which goes far beyond sensible notions of risk diversification. Tensions between the US and China are mounting. Just how much damage is China prepared to inflict via US debt markets before the mutual ramifications outweigh a simple show of force?
25/02/2010 3:15:03 PM
By Greg Peel
On Tuesday night the US Treasury auctioned US$44bn of two-year notes. Last night it auctioned US$42bn of five-year notes. Tonight it will auction US$32bn of seven-year notes. Commentators have long ago stopped noting that such sales amounts often break previous records.
Last week the US Treasury auctioned US$40bn of three-year notes, US$25bn of ten-years and US$16bn of thirty-years. Indeed, every month the US Treasury auctions off billions upon billions in bonds, notes, and shorter dated bills. This is the mechanism by which the US funds its massive fiscal and current account deficits. America goes cap in hand to the world, seeking support for the maintenance of a lifestyle to which America has become accustomed. Since around 1975, net US debt has skyrocketed, far, far beyond the growth rate of US household income. This is not debt for which the principal is ever going to be returned – ever. Only interest payments will be forthcoming.
And the world laps it up. Or at least, the world has been lapping it up so far. Everyone across the globe wants to sell goods and services into the biggest consumer market on the planet, and the only way this can be done is to lend those consumers the money to spend. It's a vicious circle which cannot be broken because a point of no return was passed decades ago. Cut off America, and you cut off your own export receipts and your own lifestyle.
Obviously the whole system is no better than a house of cards, oras others have suggested, the world's biggest Ponzi scheme. And the house nearly collapsed in 2008, but given the vicious circle meant everyone would be a loser, the simple solution was to print enough “paper” money to counter the deflationary forces of economic recession. And here we are.
The GFC has brought into focus the need to address the “global imbalance” which in simple terms can be defined as China, Germany and Japan selling goods to the US on credit while saving all the receipts. Those receipts have to be parked somewhere safe, and what better safe haven is than in debt issued by the government of the economy which is still bigger than the other three put together? And that's before we talk about who has the most bombs.
So keen has the world, and the domestic US investment market, to park its funds in this safe haven that recently US one-month Treasury bills fell to a negative nominal yield. That means even ignoring inflation, investors are paying America for the right to lend America money. How will the globe ever be rebalanced when this sort of attitude prevails?
One alternative which was previously favoured by the creditor nations post-GFC was to start diversifying out of US-only investments and to spread funds around into other sufficiently safe havens including IMF bonds, euro-denominated assets and gold. Gold provides no interest payment, nevertheless, and is volatile in price. There is no eurozone bond, and now Greece has thrown a spanner in the works of any euro-denominated assets being some sort of safe haven. IMF bonds are fine but limited, and they still have a 40% US dollar weighting.
So over there's a rock, and over there's a hard place. And the conundrum is made even rockier and harder by the fact that any full-scale withdrawal of credit to the US would result in existing investments being trashed in value. Damned if you do...
Another major problem creating global imbalance is China's pegged currency. While Japan and Germany helped America into its endless credit cycle mess, China's non-floating currency opened up a whole new world of artificial spending opportunity for Americans. There has been no one more vocal in its desires to diversify away from its massive US investments than China, but to do so is to risk both wiping out the value of its investments to date and derailing Chinese economic growth.
But Chinese economic growth would also be derailed if the renminbi was allowed to float, because suddenly China's US investments would be worth far less in its own currency and Americans would no longer find Chinese goods “cheap”. Post-GFC, China has not been selling as much to the US as previously so it is not buying quite the same amount of US debt, but China still has to buy at least some US debt. Euro investments are now off the cards, and China produces enough of its own gold, it would seem. And it has already loaded up on what IMF bonds are available.
But China has more recently been exploiting a different way to diversify its investments while still preventing a US dollar collapse, and that is simply to cut out the middle man and buy US dollar-denominated commodities – iron ore, copper, you name it. And China has been cutting out further middle men by actually buying into the companies that produce those commodities, which it has been doing across the length and breadth of the earth including in Australia.
There is only so much iron ore and copper etc China can buy nevertheless, particularly at a time when the US and West in general are no longer spending like mad on Chinese manufactured goods. Another earlier form of diversification was for China to buy not only US Treasury bonds, but US state and municipal bonds as well.
But in the latter case, Greece changed the picture, it is believed. China instructed its state investment body to withdraw from lower-rated debt and stick only to higher rated Treasury debt for fear that the building European crisis would serve to blow out credit spreads on less all reliable economies, including those of US states and municipalities. [See China Battening Down The Hatches].
Which means China is once again buying only US Treasuries. This should be some sort of comfort for America, except for one problem. It would appear China, and the world, is beginning to see the US as too much of a risk out to any length of time. In the aforementioned Treasury auctions, while foreign central bank demand for up to two-year US debt remains strong, demand any further out is waning, and waning fast. If America cannot find backers to support its printed money out to time – time for which the US deficit is expected to go on and on – then the next risk is hyperinflation, Zimbabwe-style.
The world has become tired and nervous of buying more and more longer-dated US debt. The more it buys, the more becomes available. Foreign participation rates in longer-date US Treasury auctions has been dropping alarmingly. Greece is not the only problem nation. All the world has managed to do post-GFC is take all the debt burden out of the private sector and re-establish it in the public sector. We no longer fear investment banks going down, we fear countries going down.
Another reason why China in particular would want to re-concentrate its US investments into short-date debt is because very soon China will revalue its currency by an expected 5% in order to ease off its runaway economy. This immediately has the effect of devaluing US investments, but the shorter the date the lesser the valuation impact. The same goes for wider credit spread debt such as state and municipal debt.
But there is more to the story. China has clearly been selling US bonds in recent months, rather than just not buying them. Is this just part of switching into shorter dates or is there a more insidious agenda behind the sales?
China is now in a position of considerable global power. The US may still be the world's undisputed superpower but China holds the kryptonite. For if China was to call in its US marker (sell all its US bonds) the US economy would collapse. Mind you, the result would be largely internecine, given China's surplus and export market would be wiped out, but China is not beyond flexing a bit of muscle and letting the US know just who is holding the cards here (pardon the mixed metaphor).
And China has two areas of ongoing frustration. They're called Taiwan and Tibet, and from an imperial perspective China believes it holds unalienable rights over those “countries”. China gets very upset when world leaders meet with China's “enemy” in the Dalai Lama, which President Obama did last week, and was previously furious when America agreed to sell arms to Taiwan.
On the Taiwanese front, China holds considerable power. As soon as arms contracts were announced between Taiwan and the likes of Boeing, for example, China threatened to stop buying Boeing aircraft. Given over 50% of China's airline fleet is made up of Boeing planes, and the total is rapidly growing, Boeing found itself with a difficult decision to make.
Meetings with the Dalai Lama have not elicited quite such a direct response, but suffice to say the London Telegraph has pointed out that the day Obama met with the Tibetan leader the (Communist) China Daily praised moves by the Chinese authorities to “slash” holdings of US debt.
And we won't even begin to speculate on Google's problems, general computer hacking and intellectual property theft.
What is of concern here is that a political rift is building which goes far beyond sensible notions of risk diversification. Tensions between the US and China are mounting. Just how much damage is China prepared to inflict via US debt markets before the mutual ramifications outweigh a simple show of force?