Wednesday, November 18, 2009

China as America's "Banker"

This myth should not be allowed to propagate. Unfortunately, by definition, simple messages are the most likely to flourish and reach the greatest proportion of the populace. We humans have mastered compartmentalization and categorization.

A friend sent me the following nonsense:
Why would the Chinese be so interested in our deficit? Well, for all intents and purposes, China is the official banker of the United States government. China is the number one foreign holder of U.S. Treasury securities.
And, as the Times reports, “like any banker, they wanted evidence that the United States had a plan to pay them back.”
Somehow, I doubt the President had any such evidence to give them in Beijing this week.
The Chinese are nothing if not clever. One investment banker told me that they had converted all of their debt from 30-year maturity to one year. The hard questions they are asking right now are about how much the health care bill will raise the deficit. And make no mistake, if the Chinese decide not to continue financing our debt, the dollar could drop through the floor. America could have a huge financial crisis.
Isn’t it ironic that the communist Chinese are more concerned about the cost of socialized medicine than the President and the Congress? That the Chinese communists are more concerned about the U.S. government printing money like it’s going out of style than we are?
If that isn’t a wake-up call to the politicians, the media, and to the American public, I don’t know what it’s going to take.

to which I replied:

I completely disagree with the assumptions of this article, although I tend to agree with its conclusion (that Health Care "reform" should never be passed)

First, some theory:

China cannot, will not, "call in" the "debt" of the U.S. If they did so, it would require an immediate and massive appreciation of theYuan vs. the U.S. dollar, effectively destroying the Chinese economy as its export-driven model shrinks to zero.

China is not "the bank" of the U.S. All of the paper they own is denominated in U.S. dollars. We don't NEED to "get" any money from anyone. Their holding reflect their DESIRE to hold safe assets in a safe jurisdiction. The important point is not this histrionic talk of China being able to destroy the U.S. economically, rather, its WHY ARE THEY CHOOSING TO HOLD SO MUCH OF THEIR WEALTH IN ASSETS DENOMINATED IN DOLLARS. My view on this is that their banking system is insolvent, and should the rest of their economy implode, it would require massive bail-outs by the IMF and other multi-lateral organizations. They are not saving for a rainy day. They know the rainy day is coming and are preparing accordingly.

Now, some facts:

China did not convert all their duration from long to short term.

The major foreign holders of U.S. securities can be found here. You will note that Japan holds nearly as much as China, but no-one talks incessently about how they are our "bankers".

I also note here that China has certainly not lost its appetite for U.S. dollar denominated securities. They bought 12.5 Billion of LONG TERM securities (duration 10+ years) against 4 Billion in Short-term securities ( >1year duration) in SEPTEMBER ALONE. Does this sound like they have now "converted" all their debt?

Now, I don't discount the possibility they have entered into derivative contracts to sythetically convert their bond duration to one year, but this is HIGHLY, HIGHLY, unlikely as only 1-2 banks in the world could handle such a transaction, and we would have seen U.S. long-term yields move substantially as that bank would have to hedge their own risk. Instead, the 30 year sits implacably below 3.5%.

Far more likely that the "banker" this guy spoke with did not know what he was talking about.

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