Thursday, May 21, 2009

NYT: China Becoming More Picky About Debt

There is quite the co-dependent dynamic happening between the U.S. and China. They need our consumers to support their export business, and we need them to buy up our debt so we can consume over our head... which allows them to sustain their export business! Even when they hate what we are doing they must support us [Feb 13, 2009: - China to US: "We Hate You Guys"]

While some have called out that China will eventually abandon buying U.S. debt (which would cause a potential collapse in the dollar, and our country - although the Federal Reserve would step in as a buyer - remember, the whole Banana Republic thing) the problem is timing. Many think it is imminent or "in a year or two". Nah. I agree that if the Chinese had any other choice they should (and would) be moving away. But guess what - it's a co-dependent relationship. We need their money but they need us to buy stuff. Lots of it. As they say, when a borrower owes a little money, the power is with the creditor but when a borrower owes a ton of money, the power is with the borrower <--- waddya gonna do? walk away from us now?? Here is the blurb...

China will continue to buy US Treasury bonds even though it knows the dollar will depreciate because such investments remain its “only option” in a perilous world, a senior Chinese banking regulator said on Wednesday.

Mr Luo, whose English tends toward the colloquial, added: “We hate you guys. Once you start issuing $1 trillion-$2 trillion [$1,000bn-$2,000bn] . . .we know the dollar is going to depreciate, so we hate you guys but there is nothing much we can do.”

Now that is the definition of a Jerry Springer like co-dependent couple: I hate you! But you're momma's baby daddy so I am stuck with you in my life.

A little known fact is actually China derives more exports to Europe than America, but we are still a very large impact on their GDP. Now I suspect over the coming decade China will continue to build its own in house consumption and other markets will continue to grow (Indonesia, India, Brazil) and at some point letting the US fall on its own sword will be more practical. But we're not close to that point yet. However, there are many small things going on that almost no one talks about as China tries to detach itself slowly but surely from its debt addicted junkie - we're seeing bilateral currency agreements with multiple countries, we're seeing China "stockpiling" hard assets rather than just piling the money into more US debt, we're seeing them switch from longer term paper to short term... it will be a long process but China is very patient and very methodical. The government there actually looks out more than 1 election cycle.

It also was interesting how Hank Paulson last fall said everything was fine with Fannie, and Freddie (remember, he had his bazooka!) and then China said they wanted guarantees on their agency debt holdings, and lo and behold look who they made jump when they said "jump"! Mr Paulson quickly effectively nationalized the two within days of the Chinese comment... I am sure it was just "happenstance". So we can sit here smugly and say we're the power, but really the Fannie, Freddie episode shows me how desperate the junkie can become when the dealer raises a fuss.

Folks, we are not changing or improving our behavior - in fact we're getting worse. Our debt load grows, and we continue to ignore our long term issues. Entitlements, pensions, state budgets, bailing out the oligarchs - all of it is solved by looking the other way and kicking the can or creating more debt. For those of us who actually pay attention (a small minority in the country) we simply lurch from one emergency to another and what "solves" emergency A creates new historic problems B, C, and D 3-7 years down the road. That's now official policy response. It will all end badly - just a matter of when and how it ends. If I were China and I wanted to take the mantle as sole superpower, I'd continue to give the US as much rope as it wants (to hang itself), and then in 12-15 years say "no mas" all at once. The fireworks would be spectacular. But for now they can't go cold turkey - but per this NYTimes piece they are getting more picky in their demands.

(click to enlarge)

  • Leaders in both Washington and Beijing have been fretting openly about the mutual dependence — some would say codependence — created by China’s vast holdings of United States bonds. But beyond the talk, the relationship is already changing with surprising speed.
  • China is growing more picky about which American debt it is willing to finance, and is changing laws to make it easier for Chinese companies to invest abroad the billions of dollars they take in each year by exporting to America. (we saw the announcement a few weeks ago to allow investment in Taiwan) For its part, the United States is becoming relatively less dependent on Chinese financing.
  • China has actually bought Treasury bonds at an accelerating pace over the last year — notwithstanding Chinese officials’ complaints about American profligacy. But the borrowing needs of the United States government have grown even faster. So China represents a rapidly shrinking share of overall purchases of Treasury securities.
  • Americans and investors elsewhere are buying Treasuries instead. They are saving more and have been shifting out of other investments — including equities until the past two months — and into Treasuries.
  • China bought less than a sixth of the Treasuries issued in the 12 months through March.
  • Less than two years ago, by contrast, Chinese purchases of Treasuries, which included purchases in the secondary market as well as newly issued securities, briefly exceeded the entire borrowing needs of the United States.
What's happening under the surface?
  • Financial statistics released by both countries in recent days show that China paradoxically stepped up its lending to the American government over the winter even as it virtually stopped putting fresh money into dollars.
  • This combination is possible because China has been exchanging one dollar-denominated asset for another — selling the debt of government-sponsored enterprises like Fannie Mae and Freddie Mac in a hurry to buy Treasuries.
Why you may ask? Well the Federal Reserve is now buying about 80% of all issued Freddie and Fannie debt. So it's a big shell game. This is quantitative easing of another nature. Instead of directly buying US Treasuries (over and above the $300B the Fed has promised) we've shifted the Chinese into that role, and then the Federal Reserve picks up the slack by buying agency debt.

So this way we look less like a Banana Republic... because if the Chinese were buying their old levels of agency debt, the Fed would have to be buying huge swathes of Treasuries. Hey - lookee here, try to find the debt! It's not under this shell, or that one! Tricked ya - it was under shell #3. This method allows us to save face and pretend we are not basically buying from ourselves day and night.
  • ... new data shows that China is also trading long-term Treasuries for short-term notes, highlighting Beijing’s concerns that inflation will erode the dollar’s value in the long run as America amasses record debt. It has done so in ways calculated to reduce its exposure to inflation or other problems in the United States. As recently as a year ago, China actively bought long-dated bonds, seeking the extra yield they could bring compared to Treasury securities with short maturities, of which China bought virtually none.
  • But in each month since November, China has been buying more Treasury bills, with a maturity of a year or less, than Treasuries with longer maturities. This gives China the option of cashing out its positions in a hurry, by not rolling over its investments into new Treasury bills as they come due should inflation in the United States start rising and make Treasury securities less attractive.
  • So China’s rising purchases of Treasuries do not represent the confident bet on America’s future that they might seem to be on the surface. For instance, China does not appear to be dumping euros or yen to buy Treasuries, economists said.
  • That said, recent Chinese and American data suggest that an astounding 82 percent of China’s $2 trillion in foreign reserves is in dollars.
  • “We have lent a huge amount of money to the U.S. Of course we are concerned about the safety of our assets. To be honest, I am definitely a little worried,” Mr. Wen said earlier this year.
There is no free lunch; stock market participants are simply gleeful that risk has been taken away from them and instead hoisted onto the back of the US taxpayer. Eventually that taxpayer will pay... and in spades; either through currency or inflation crisis. When the world returns to normal, US Treasuries won't be the place to park money - rates will need to go up to compete for capital inflows with other countries. [Nov 21, 2008: Bookkeeping: Initiating Ultrashort Lehman 20+ Year Treasury] But for now - let's keep kicking the can and whistling - sticking our head in the sand also helps provide glee (I also believe green shoots grow underground). Maybe we can do it for a decade more.

p.s. my prediction for the first ever $2 Trillion Annual Budget Deficit I made in latter 2008 is looking like a home run. (remember the worst ever before this year was last year's $400Billion-ish!) Meanwhile what were those "in the know" telling you at the beginning of the year? [Jan 7, 2009: CBO Projects $1.2 Trillion Deficit in 2009] One blogger with common sense could project better than an entire government department. But don't you worry - deficits don't matter (source: Dick Cheney)

[Mar 29, 2009: CNNMoney: Should USA Still be AAA?]
[Nov 12, 2008: CNBC Europe - USA May Lose its AAA Rating]
[Apr 15, 2008: Could the US Lost its AAA Rating?]

[Jan 8, 2009: New York Times - China Losing Taste for US Debt]
[Dec 26, 2008: Japan Should Just Begin Writing off US Debt]

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