"Why Is China's Prime Minister Complaining About the Risk of Holding U.S. Government Bonds?
By all accounts China's Prime Minister, Wen Jiabao, is an intelligent man. Therefore he knows that China will lose a substantial portion of its investment in U.S. Treasury bonds. This raises the question of why he is complaining about the risks in China's holding of U.S. Treasury bonds, when he knows that there is no risk, the investment is a sure loser.
The loss will come for two reasons.
First, the United States is running a large trade deficit. The only way that this surplus can be sustained is if the Chinese government and other central banks continue to buy up ever more U.S. dollars, thereby preventing the currency from falling. If the Chinese government ever stops buying vast amounts of U.S. dollars, the dollar will fall in value against other currencies (as it did in the years 2002-2007) causing China large losses on its holdings.
But, this loss is China's decision, not the result of U.S. government policy. As long as China wants to spend hundreds of billions of dollars each year propping up the dollar, it can prevent losses on its prior holdings due to a fall in the value of the dollar, but there would be no reason for Mr. Wen to complain about a policy that he or his successor will decide.
China will also lose money on its bonds because the interest rate on U.S. Treasury bonds will almost certainly rise as the economy recovers. The Congressional Budget Office projects that the yield on 10-year Treasury bonds will rise from 3.0 percent today to 4.8 percent in a few years. This would imply a loss of about 15 percent in the value of a 10-year Treasury bond.
For these reasons, Mr. Wen knows that China will lose money on its Treasury bond holdings. The news reporting on his comments should be asking why he is complaining about the risk of losses that he knows are virtually certain.
--Dean Baker
Me:
Actually, that question was addressed:
http://www.ft.com/cms/s/0/ba857be6-f88f-11dd-aae8-000077b07658.html
"China to stick with US bonds
By Henny Sender in New York
Published: February 11 2009 23:33 | Last updated: February 11 2009 23:33
China will continue to buy US Treasury bonds even though it knows the dollar will depreciate because such investments remain its “only option” in a perilous world, a senior Chinese banking regulator said on Wednesday.
China has used the dollars it accumulates selling manufactured goods to US consumers to accumulate the world’s largest holding of Treasuries."
And:
"Mr Luo, whose English tends toward the colloquial, added: “We hate you guys. Once you start issuing $1 trillion-$2 trillion [$1,000bn-$2,000bn] . . .we know the dollar is going to depreciate, so we hate you guys but there is nothing much we can do.”
But remember this:
http://blogs.cfr.org/setser/2009/01/29/read-dean-areddy-and-ng-on-the-ma...
“It turns out that one of China’s main criticism of US policy is simple: the government didn’t stand by institutions that China expected the US to support. Lehman. Wamu. And the Reserve Primary Fund. Dean, Areddy and Ng:
“Leaders in China, the world’s third-largest economy, have been surprised and upset over how much the problems of the U.S. financial sector have hurt China’s holdings. In response, Beijing is re-examining its U.S. investments, say people familiar with the government’s thinking. …
Chinese leaders have felt burned by a series of bad experiences with U.S. investments they had believed were safe, say people familiar with their thinking, including holdings in Morgan Stanley, the collapsed Reserve Primary Fund and mortgage giants Fannie Mae and Freddie Mac.”
Once again, I see them weighing in on the option of defaulting on the bonds on our large banks, and other such assets. They are saying that they assume that the government is on the hook for guaranteeing the bonds, not the banks.
It's one thing to pay a premium for safety and liquidity, it's another to be completely defaulted upon. Also, the don't like the default trend line.
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