Friday, September 16, 2011

Will China Begin to Sell Treasurys?

Over the years, as the Chinese government continued to invest its burgeoning foreign exchange reserves into our bond market, there have been repeated worries that the day would come that the Chinese would begin to sell.

I have never put much credence in these worries, frankly.

Our US Treasury represents the largest, most liquid capital markets in the world. In addition, our legal system offers significant protections to investors, which is not always the case elsewhere in the world.

But lately I have begun to think that, well, maybe we shouldn't just take the Chinese investment in our government bonds for granted.

Over the past year the Chinese have begun more vocal in their concerns over our political bickering. It must have caused some angst in Beijing at the end of July when only a last minute compromise prevented a default on US debt.

Then there are the repeated calls from economists - notably Kenneth Rogoff from Harvard - that the Fed should work to restoke inflationary pressures in order to reduce our onerous debt burdens. While inflation would be a welcome respite for borrowers, the Chinese own trillions of dollars in US debt whose real value would be diminished if inflation were to increase again.

The recent calls from Europe for China to move some of its reserves to the euro may resonate with finance officials in China.

Not that the Chinese particularly care about the crippled state of the European banking system, but rather it is in their own trading interests to make sure that Europe stays afloat.

In addition, buying euro bonds would also be a way for the Chinese to communicate to our leaders that our debt is not necessarily the only "game in town".

Random Glenings fave columnist Ambrose Evans-Pritchard of the London Telegraph wrote a piece yesterday indicating that the Chinese are now thinking of moving out of Treasury notes into other dollar-denominated assets, including stocks. Here's an excerpt from his piece:

A key rate setter-for China's central bank let slip – or was it a slip? – that Beijing aims to run down its portfolio of US debt as soon as safely possible.

"The incremental parts of our of our foreign reserve holdings should be invested in physical assets," said Li Daokui at the World Economic Forum....

...So what Li Daokui said is not bad for the dollar as such. He said there is "$10 trillion" waiting to be invested in the US, if America will open its doors.

It is bad for bonds – or will be. The money will go into strategic land purchases all over the world, until the backlash erupts in earnest. It will go into equities, until Capitol Hill has a heart attack. It will go anywhere but debt.

Yet another reason to be careful of 10-year Treasuries and Bunds below 2pc yields. There is a big seller out there, just itching to let go.