Is China Dumping or Accumulating U.S. Treasuries?

The latest Treasury International Capital (TIC) report shows that, at the end of 2009, China was no longer the largest foreign owner of Treasury securities, having relinquished back to Japan the No. 1 spot it had claimed in September 2008. Between November and December, mainland China's holdings fell 4% to $755.4 billion. Is this a bad omen for the U.S. government and Treasury bond holders alike?

China must keep its appetite
If Chinese appetite for U.S. debt wanes and there is no one to make up the shortfall in demand, government bond yields could rise, creating losses in bond portfolios (those of investment banks, for example -- see table below) and putting increasing strain on the U.S., which needs to finance ballooning deficits.

 

U.S. Treasury Securities Holdings (Available-for-Sale & Trading Assets), Latest Quarter

Bank of America (NYSE: BAC  )

$50.7 billion

Citigroup (NYSE: C  )

$27.0 billion

Goldman Sachs (NYSE: GS  )

$25.8 billion

JPMorgan Chase (NYSE: JPM  )

$25.3 billion

Morgan Stanley (NYSE: MS  )

$19.2 billion

Total

$148.0 billion

Source: Capital IQ, a division of Standard & Poor's.
Note: Available-for-sale and trading assets must be marked to market. For the former, gains and losses are reflected on the balance sheet, affecting the value of bank capital. For the latter, gains and losses show up directly on the income statement.

Beyond the headline numbers
Not so fast. According to The Wall Street Journal's "Heard on the Street" column, the doubling in U.K. and Hong Kong holdings of U.S. government securities over the past year suggest that China could be the ultimate owner of some of the bonds in these financial centers. Besides, China's "direct" holdings are still larger than they were a year ago.

The truth of the matter is that although China would like to reduce its dollar exposure, there is a distinct lack of alternatives (for China, not for individual investors). Furthermore, China is locked in a risky tango with the U.S. -- U.S. consumers buy Chinese goods, China recycles the dollars it accumulates into dollar assets, which enables it to maintain the yuan at a depressed level ... which ensures its exports goods remain competitive. So the cycle continues, exacerbating global imbalances.

Watch this duo
Similar to the extraordinary liquidity central banks injected into the banking system in the crisis, U.S. and Chinese policymakers will eventually need to curb this cycle (gracefully, if possible). Investors need to add this to their mental checklist of macro-level risks for this decade. The path the U.S. and China select will have an enormous impact on the global economic and investing environment.

China is concerned about the value of the dollar, and U.S. investors should be as well. Tim Hanson explains why it's time to get out now!

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Fool contributor Alex Dumortier loves macro-themed investing; you can follow him on Twitter. He has no beneficial interest in any of the stocks mentioned in this article. Try any of our Foolish newsletters today, free for 30 days. The Motley Fool has a disclosure policy.


Read/Post Comments (5) | Recommend This Article (3)

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  • Report this Comment On February 19, 2010, at 4:07 PM, theHedgehog wrote:

    OTOH, as long as US consumers keep sending USD to China by the boatload, China has to find a way to get rid of them. If they don't buy US treasuries, then what? Oil? Other commodities? Us businesses? US Real Estate? In any case, the wheel keeps spinning, and the USD continue to be put to work. As a country's money has no intrinsic value anywhere it's not used as a medium of exchange, those USD will continue to come back to the US in some form or other.

  • Report this Comment On February 19, 2010, at 4:08 PM, theHedgehog wrote:

    OTOH, as long as US consumers keep sending USD to China by the boatload, China has to find a way to get rid of them. If they don't buy US treasuries, then what? Oil? Other commodities? Us businesses? US Real Estate? In any case, the wheel keeps spinning, and the USD continue to be put to work. As a country's money has no intrinsic value anywhere it's not used as a medium of exchange, those USD will continue to come back to the US in some form or other.

  • Report this Comment On February 19, 2010, at 5:42 PM, DanseMacabre wrote:

    If they were to dump US Treasuries/USD, that would weaken the USD compared to their currency. This means that Americans would be less able to buy Chinese goods (being relatively more expensive), and that buyers across the world would become more able to buy American exports compared to Chinese ones. This would hurt or end China's trade surplus. Currently, some have described China's trade policy as mercantilistic (sell as many exports as possible, buy as few imports as possible, buy your trading partners' currency to keep this policy, and pretend that you are rich). This process cannot go on forever (China will have to push itself beyond the limit to keep buying Treasuries and USD), so, according to Stein's Law ("If something cannot go on forever, it will stop,"), the USD will weaken and Chinese currency (renminbi) will strengthen, creating balanced trade. The question is whether this will happen over many years (through market forces), or through a few years (if the US decides to artificially weaken the dollar).

  • Report this Comment On February 19, 2010, at 5:50 PM, DanseMacabre wrote:

    If China were to dump USD and Treasuries, the USD would weaken relative to the Chinese currency. This would hurt or eliminate China's trade surplus with the US, since Chinese goods would become comparatively more expensive (and thus less accessible), and American exports would become comparatively cheaper for other countries (possibly including China). Since the Chinese cannot keep pumping up the US dollar forever (there is a limit to how long they can realistically keep buying Treasuries), the USD will fall compared to the Chinese currency (renminbi). The question is whether this will be through market forces (taking a few years) or through direct action on the part of the US Government to weaken the dollar compared to Chinese currency. Either way, I think there will eventually be balanced trade, and I am long-term bearish on the dollar.

  • Report this Comment On February 20, 2010, at 12:47 PM, DanseMacabre wrote:

    Sorry--I thought my previous post had been accidentally deleted, and typed another one. My apologies.

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