With the interest in China over the past week or so on this blog, this excerpt from today's NY Times caught my eye:
The declining Chinese appetite for United States debt, apparent in a series of hints from Chinese policy makers over the last two weeks, with official statistics due for release in the next few days, comes at an inconvenient time.Now this development is not that big of a deal in the short run, as demand for Treasury's is at an all-time high and yields on everything from 4-week to 3-month Treasury's have gone negative over the past month. So a short run Chinese pullback from purchasing US debt may very well be usurped by increasing demand and a strong market for the extremely safe asset.
On Tuesday, President-elect Barack Obama predicted the possibility of trillion-dollar deficits “for years to come,” even after an $800 billion stimulus package. Normally, China would be the most avid taker of the debt required to pay for those deficits, mainly short-term Treasuries, which are government i.o.u.’s.
In the last five years, China has spent as much as one-seventh of its entire economic output buying foreign debt, mostly American. In September, it surpassed Japan as the largest overseas holder of Treasuries.
But now Beijing is seeking to pay for its own $600 billion stimulus — just as tax revenue is falling sharply as the Chinese economy slows. Regulators have ordered banks to lend more money to small and medium-size enterprises, many of which are struggling with lower exports, and to local governments to build new roads and other projects.
However, in the medium term (say 12-18 months from now), this development may indeed hurt the United States. As China pulls back (forecasts show that China’s foreign reserves will increase by $177 billion this year, down sharply from an estimated $415 billion last year) and continues to pull back, and the markets rebound in the medium term, demand will shift from the debt markets to equities or whatever new instruments are in vogue at that time. This would drive up the interest rates that investors would demand for Treasury's, thus making it more expensive for the US to borrow. Interesting development to watch for over the next 12-36 months.