Thursday, July 23, 2009

Is China Really Pulling Away from American Debt?

. Thursday, July 23, 2009

The Chinese say that they will be diversifying away from T-Bills:

“This is reserve diversification in a broader sense. Instead of accumulating foreign exchange reserves and short-term financial assets, the government wants the nation to accumulate more long-term corporate real assets.”

State-owned groups, particularly in the oil and natural resources sectors, have stepped up their hunt for overseas companies and assets on sale because of the global crisis.

Of course if China stops buying T-bills it will put downward pressure on the dollar, make the servicing of our deficits more costly, and making our imports more expensive (thus making us poorer). So if the Chinese are truly diversifying away from the dollar, or away from government debt, then it could spell trouble. This is the "Great Adjustment" that economists like Nouriel Roubini have been warning about for years. This was how Chimerica was supposed to fall apart.

But the Chinese have been making these sorts of threats for years without following through, and I've learned over the years to never form an opinion on Chinese sturm und drang without consulting Brad Setser first. He says:

For a while in 2007 and 2008 the growth in China’s US holdings lagged its reserves. Chalk that up to diversification. The gap between China’s known US assets and its reserve growth came at a time when China was buying more “risky” US assets, like equities — and likely increasing its exposure to a host of potentially “risky” emerging economies. Or chalk it up to increased use of private fund managers, including the money market funds used by the CIC. China’s dollar holdings likely increased a bit more rapidly than the US data implies.

Then for a brief period last fall China’s “safe” US holdings rose far faster than its reserves. That likely reflects a shift out of riskier assets – and a shift away from privately managed funds — back towards classic reserve assets. I don’t know precisely what drove the surge in recorded inflows to the US. But something changed. After a period when inflows to the US lagged, they suddenly surged — with almost all the inflow going toward short-term bills

And now China’s US holdings – particularly its Treasury holdings – seem to be rising in line with China’s reserves.

China is still buying other assets. Chinese state firms have been actively bidding for mineral rights – and companies that have mineral rights. And China has been stockpiling commodities. But over the last few months SAFE has essentially been buying Treasuries at – best I can tell – more or less the rate implied by China’s reserve growth.

Setser has charts and graphs to prove it, if that's your thing. The gist seems to be that China is diversifying, but their reserves are so large (over $2tn, and growing rapidly) that they are still buying T-Bills as well. Remember, the China Investment Corporation got burned badly when the equity markets tanked last fall, and the Chinese government has demonstrated strong risk-aversion time and time again. So while they do continue to diversify, their holdings of T-bills will continue to grow as long as their foreign reserves keep growing.

Emmanuel at IPEzone offers further comment.


Is China Really Pulling Away from American Debt?
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