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China T-bond sales fears. Real or imagined?

Paddy Hirsch Aug 17, 2011

With Vice President Joe Biden in China, plenty of commentators are once again talking about China selling US Treasuries.

Some reports say China is worried about the US credit rating, its already enormous debt load, and a political stalemate in Washington DC that will make it difficult to make big cuts in America’s debt load in the future.

China holds $1.16 trillion in US debt, and some peope think it’s getting ready to dump the lot. That fear is grist for the political mill, just as the presidential election campaigns are warming up, so we’re likely to hear a lot more about China and bond sales and possible economic apocalypse in the coming months.

Twenty years ago, people used to say the same thing about Japan. One relative of mine used to mutter darkly that Japan was holding us to ransom, and could crash the US economy in a second if it wanted to. Of course, that never happened – we crashed it ourselves. Today, people mutter the same stuff, but now China is the bogeyman.

Economists aren’t immune to fears of a China bond dump, so every time China decides to shake things up a bit and makes noises about ditching treasuries, experts routinely trot out the litany of horrors that could result if China were serious. First, everyone else would sell, and not just Treasuries. They’d sell the dollar, too. Second, the US would have to jack up its interest rates to sell more of its bonds. Third, those rising rates would ripple through the US economy, raising the price of borrowing for everyone, from a corporation buying a competitor, to a woman buying a car – people would stop both borrowing and buying. Fourth, companies would cut back, producing less, hiring less, and laying off more, and suddenly you’re in the vicious cycle of recesson.

The economists aren’t necessarily wrong about what would happen if China did indeed dump all of its US debt holdings. The question is, how likely is it to happen? China watchers and economists of all ideological leanings say … not that likely.

For one thing, China and the US are highly interdependent. Fareed Zakaria has a great video on CNN laying this out. He basically says that if China decided to take the US down by selling its debt, the US would bring China down with it, hammering their industry and the value of the yuan.

The next reason China wouldn’t sell, is that it’s got nowhere else to go. This is a country sitting on roughly $2 triilion in surplus cash, which has to be invested somewhere. Where esle will China go? Gold? There’s not enough, it’s way to expensive and far too volatile. Corporate bonds? Too subject to shock, and thus way too risky. The Swiss Franc? Not the way the Swiss are talking about adjusting their curency. The Euro? Um, not just now, thanks awfully.

Michael Pettis has a column today scoffing at the latest rumors, which were sparked by a recent article in the South China Morning Post.

China will press ahead with diversification of its US$3.2 trillion in foreign exchange reserves, the State Administration of Foreign Exchange (SAFE) said on Thursday, adding it does not intentionally pursue large-scale foreign currency holdings. Officials have long pledged to broaden the mix of the country’s huge reserves – as much as 70 per cent of which are now in US dollar assets, according to analysts’ estimates – but the process has been gradual.

Pettis points out we’ve been hearing these kinds of noises every six months or so for years, and nothing ever happens. The relationship between the US and China doesn’t change. They may glower at each other and sometimes even raise their voices, but this is a couple that is almost inescapably intertwined.

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