China and US Debt - What am I missing here?

Water Cooler Investing
#1

I admit reading a little to much Zero-Hedge and other bearish blogs recently.

Obviously, it is very hard for anyone to get a clear view of where the hell the world is heading. You’ve got the hyperinflation gold bugs. Then you have the Ray Dalios of this world who are talking about the most “beautiful deleveraging” in recent history.

The graph in the following link shows a situation that has been known for some time now, which is that China (in this case, but this seems to apply to many US creditor countries) is diversifying away from U$ assets :

http://www.thetrader.se/2012/03/19/prepare-for-the-summer-storm-of-2012/

I have heard many times that it isn’t as bad as it seems, as China would continue to hold and buy U$ debt, because it can’t allow its currency to appreciate against the dollar.

Now, China has just reported a trade deficit (for the first time in [?] years) , and seems to be shifting away from its hugely export-based model.

Wouldn’t that mean that they are in fact going to start dumping their U$ financial assets and let the yuan appreciate ?

Why is nobody freaking out ? What am I missing here ?

Txs 4 insight.

#2

Bump. Am I doing something wrong here ?

Has this been discussed revently already ?

#3

not going to act like I am a economist here, but 3 things

  1. china is not dumping anything

  2. deficit was partly seasonal (new year or something) but this is not a major negative (yet)

  3. China cannot let the Yuan appreciate too fast…they’re an export based economy at the moment and higher FX rates will choke off their exports…Yuan will rise when (along with other factors) domestic consumption grows and when private investment picks…

no need to worry here…china is in for some type of landing, but it won’t be the end of the world…China’s biggest problem is not their housing bubble or whatever, its their problem with corruption and lack of justice, and free speech…

#4

+1 Frank

China will eventually move to a more consumption based economy, but it’s not going to happen overnight. They still need to keep the yuan at an undervalued level and they will still need to keep buying US treasuries, just maybe not to the extent they have in the past.

Also, considering interest rates in the US are effectively zero, and can only go up ,would you be a buyer or a seller of US govt bonds at the moment?

#5

I am not sure that I understand your logic. The FED would want to raise the federal funds rate by selling governement securities, therefore pushing prices of said securities down and therefore bringing yields up.

#6

Well exactly, you’re sitting on $1 trillion of treasuries. The Fed starts raising rates and you take a hit on the value of your bonds as the price falls - forget about the rising yield, that’s for new buyers of US debt. Any existing holders are going to lose money as the value of the debt craters.

#7

I think the idea is that they will simply let debt mature and reinvest in other assets. This means the long end will start to creep up faster than the short end of the yield curve, but China won’t be as exposed to that part, going forward. Meanwhile, at the shorter end, the yield might also start to rise , but the duration is less, so they won’t take as much of a hit anyway.

#8

I’m not so sure China is worried that if rates go up their bonds will be marked to market…if china were to sell their trillion rates will inevitably go up anyways…that whole problem or worry about rates go up and bond values go down are more for traders who doens’t have the capacity to hold onto paper losses…

the trillion dollars represent the net impact of trade, and the surplus country has to reinvest the proceeds somehow someway…they can buy stocks/bonds/commodities etc but inevitably they have to hold US dollars which ultimately will depreciate if the status quo of trade continues…i’m missng out some nuances but its the economics of trade…you can’t trade with a country without somehow receiving something in return…whether what you receive is going to go up/down is an afterthought since you decided the trade was benefitical to your operations to begin with…

#9

There’s also the problem of where to put $1 trillion. Treasuries are the only market deep enough for China to invest that type of money. As we’re seeing, they’re buying other assets (read: gold) on the margin to diversify their asset base.

We should talk about the ensuing currency war. This is going to be fun.

#10

the chinese economy is a lot weaker than ppl think, that is my intuition…their growth rates after taking into account inflation is just around 3%…with a housing bust ensuing, political instability and social unrest, China might end up holding the HCBs hostage…

#11

I think that this is one of the main issues. Would you care to elaborate on that ?

Do you know roughly what is due when, and what are the implications ? I believe that China holds around 8-10% of total US public debt, and around 25% of foreign-held US public debt. Let’s imagine that 5% of that debt matures within 3 years, and they simply let it mature, i.e. don’t roll it over, what happens then ? Isn’t that when borrowing costs start to rocket, especially given that there could be some domino effect (Japan also holds a trillion, and I believe also intends to diversify away) ?

#12

I don’t know what the maturity structure of Chinese UST assets are - I’m sure someone out there has at least an estimate. I really have no idea and have generally assumed that it’s more-or-less laddered, but I am happy to change my opinion on the basis of better evidence.

So let’s supposed that China buys its last 10y treausry today and is diversifying out of USTs by letting stuff mature. Three years from now, that 10y T-note is now a 7-year T-note. There are fewer buyers for new 10y, so clearly the yield pressure will be to push the 10y rate up, unless the Fed makes up the difference (which is possible).

In those three years, a bunch of 1y and 2y and 3y debt has also matured. If China decides not to reinvest there, then the whole yield curve will start to rise more or less in parallel (though presumably with some ‘preferred ecosystem’ effects so it won’t be perfectly parallel).

On the other hand, China may be ok with short term debt, which has less interest rate risk and also less inflation risk. It’s also unlikely that they will completely abandon USTs in their asset allocation, since the sensible thing is not to toss out all USTs, but simply to have a smaller amount of them.

In fact, if they are still going to have a fair number of USTs in their reserves, maybe it doesn’t make sense to abandon the long end completely, and instead simply have a smaller total sum and then ladder.

I suspect, however, that a prudent Chinese central banker will be more nervous about the long end of the UST curve than the short end, and so this will mean that China will still be buying more short-term US debt and simply holding off on the long end a bit more, letting 10ys turn into 7ys and 7ys into 5ys.

Anyway, I have no privy information on this, it’s just what I think the most likely scenario is.

#13

So lower indirect bidders (China) should result in higher yields? It’d be interesting to see the correlation.

#14

As I reread this, I realized that I forgot that US can and probably will shift its debt maturity structure in response to demand. If demand for 10y treasurys decreases, the US Treasury can respond by decreasing the supply of debt issued as 10y and start issuing more 7y and 5y notes to compensate.

That would support the idea that the long term increases in yields will be spread out more across the curve, although it still may be a little more pronounced at the long end.

#15

Boom!