Couples therapy: China and the U.S.

Nixon & Mao: Mutual dependence goes back a long way.   Source: www.china-profile.com
Nixon & Mao: Mutual dependence goes back a long way. Source: http://www.china-profile.com

I have long said in my China posts that China does not have a lot of options right now besides buying US treasuries.  The AP article below describes how China has increased its purchases of US debt in recent months.  If you are going to hold your currency undervalued in order to run massive current account surpluses and amass fx reserves — because you were spooked by how the likes of Korea, Indonesia and Thailand were brought to their knees with low fx reserves in the 1998 Asian Crisis — then you will have to invest your massive fx reserves somewhere.  The dollar is a logical choice because of trade, deep US markets and the dollar’s reserve currency status. 

Since the beginning of the Great Recession of 2008-09, many observers warned that Chinese fx reserves could be shifted suddenly to other currencies, perhaps the euro and the yen.  Even before the sovereign debt crisis in Europe unfolded earlier this year, I suggested that euro assets did not look so great — given the slow-growth, sclerotic economies in the euro zone.  The same goes for yen assets, given that Japan has barely grown in the last twenty years.   Other emerging market economies (Brazil, India) are growing smartly, but they have small asset markets, compared to the depth and variety of markets in developed countries.  Ben Bernanke used to argue before the Great Recession that capital floods the US market and causes, rather than finances, US current account deficits.  This is because the return on US assets — driven by robust US output growth — is better here than elsewhere.  Now, with the euro crisis in full swing and Japan still stagnant, his argument has some appeal again.  It is still specious because it gets US households with their abysmal savings record off the hook, and it gets Bush and his irresponsible tax cuts off the hook as well.  The latter got Bernanke appointed to the Fed, so was all in a day’s work.

Is there a problem with all this foreign investment in US assets?  Yes.  The US must reduce its imbalances with the rest of the world in order to avoid the financial havoc that a massive dumping of dollar assets in the future could wreak.  We’re okay now because dollar holders have few options and the rest of the world looks a bit dodgy.  But foreign holdings are large.  Foreign holdings of US treasuries represent 28% of US GDP, with China holding 23% of this and Japan coming in second with 20%.  The US government is in hock to East Asia.  

Another nettlesome problem of this foreign appetite for the relative safety of US treasuries is that it keeps interest rates low in America, putting less pressure on Barack Obama & Co. to come up with a medium-term fiscal consolidation plan.  They’re still talking about another fiscal stimulus.  US government debt is set to rise above 90% of GDP next year and deficits will hover near 10% this year and next.  Government debt is often measured relative to GDP, but a better measure is debt relative to government revenues; this is because governments after all must service debt with revenues.  US government debt to revenues last year was 300%, higher than just about any other investment grade country in the world, with the notable exceptions of Japan and India.  (Debt by this measure was likewise higher than in such euro-crisis countries as Greece and Italy.)  So, the US has a fiscal migraine, while the Obama administration fiddles.  The Economist last week said this about Obama: “…he has done little to fix the deficit, shown a zeal for big government and all too often given the impression that capitalism is something unpleasant he found on the sole of his sneaker.”  Scrape that off your sneaker, tell OMB Director Peter Orszag to zip up his pants, and get to work!

And let’s be glad the Chinese are still buying, but not get too cozy in the knowledge of the same…

Image above: Nixon and Mao: Mutual dependence goes back a long way.  Source:  http://www.china-profile.com

From AP:

China and other countries buy US Treasury debt

China boosts holdings of US Treasury debt by $5 billion, second consecutive monthly gain

ap

Martin Crutsinger, AP Economics Writer, On Tuesday June 15, 2010, 11:38 am EDT

WASHINGTON (AP) — China boosted its holdings of U.S. Treasury debt in April for the second straight month as total foreign holdings of U.S. government debt increased.

China’s holdings of U.S. Treasury securities rose by $5 billion to $900.2 billion in April, the Treasury Department said Tuesday. Total foreign holdings rose by $72.8 billion to $3.96 trillion.

The sizable gains are being driven by fears that Greece and other European governments could default on their debt. Worries over possible defaults have sparked a flight to safety and that has benefited U.S. Treasury securities. Treasurys are considered the world’s safest investment — the U.S. government has never defaulted on its debt.

The April increases eased concerns that lagging foreign demand will force the U.S. government to pay higher interest rates to finance its debt with private economists forecasting strong gains in May as well because of the debt crisis.

“We will state the obvious that flight to safety will most likely continue to favor the United States in the second quarter,” said Win Thin, senior currency strategist at Brown Brothers Harriman & Co. in New York. “Given that the European crisis intensified in May, we would expert further large-scale inflows.”

Gregory Daco, U.S. economist at IHS Global Insight, said that demand for U.S. debt was also being helped by the fact that the profit outlook for many U.S. companies is bright and the U.S. economy is forecast to grow at a stronger pace this year than Europe.

China is the largest foreign holder of Treasury securities. The monthly gains in March and April came after six consecutive months when China was either reducing its U.S. holdings or keeping them constant. The stretch raised concerns that China might shift money away from Treasury securities.

The 1.9 percent rise in total holdings of U.S. debt in April followed an even bigger 3.5 percent increase in March.

The Treasury reported that net purchases of long-term securities, covering U.S. government debt and the debt of U.S. companies, increased by $83 billion in April. That follows a record monthly gain of $140.5 billion in March.

The higher interest in U.S. bonds has helped push interest rates lower. It’s a welcome development for the government, which faces the task of financing record federal budget deficits. The federal deficit hit an all-time high of $1.4 trillion last year. It is expected to remain above $1 trillion this year and in 2011 as well.

Japan, the No. 2 foreign holder of Treasury securities, also increased its holdings in April. It boosted them by $10.6 billion to $795.5 billion.

Other countries registering gains in their holdings in April were the United Kingdom and various oil exporting nations.

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