"China’s new barbell portfolio: Treasuries and commodities?
Keith Bradsher’s New York Times story on the recent evolution of China’s foreign portfolio gets — at least in my view — the story right. Of course, that may be because I was — rather obviously — a source for the story. Check out the charts that accompany the article!
The basic story of China’s foreign portfolio is simple: it is trying to reduce the amount of (credit) risk in its fixed income portfolio while simultaneously taking on more commodity risk.
China’s purchases of Treasuries (especially short-term bills) have gone up even as China’s reserve growth has slowed, as China shifted money out of Agencies and — in all probability — out of money market funds that are taking credit risk and other privately managed accounts. The failure of Reserve Primary had a big impact on China. Bradsher:
“Financial statistics released by both countries in recent days show that China paradoxically stepped up its lending to the American government over the winter even as it virtually stopped putting fresh money into dollars. This combination is possible because China has been exchanging one dollar-denominated asset for another — selling the debt of government-sponsored enterprises like Fannie Mae and Freddie Mac in a hurry to buy Treasuries. ….
China was the world’s biggest buyer of [securities issued by government-sponsored enterprises] a year ago, splashing out more than $10 billion a month. But in the 12 months through March, it actually had net sales of $7 billion, and ramped up purchases of Treasuries instead. China has also changed which Treasuries it buys. It has done so in ways calculated to reduce its exposure to inflation or other problems in the United States. As recently as a year ago, China actively bought long-dated bonds, seeking the extra yield they could bring compared to Treasury securities with short maturities, of which China bought virtually none. But in each month since November, China has been buying more Treasury bills, with a maturity of a year or less, than Treasuries with longer maturities. This gives China the option of cashing out its positions in a hurry, by not rolling over its investments into new Treasury bills as they come due should inflation in the United States start rising and make Treasury securities less attractive.
At the same time, China has sought to ramp up its exposure to commodities. China’s government clearly is adding to its strategic stockpiles — and perhaps encouraging state firms to build up inventory as well. China’s government is encouraging Chinese state firms to invest more abroad, especially in the mining sector. And China’s government is providing financing to cash-strapped commodity exporters (Russia, Kazakhstan, Brazil and no doubt others) to help tide them through a rough patch and, China hopes, to secure future supplies. Bradsher:
“This spring China has also been stepping up its purchases of commodities, which are usually bought in dollars. Iron ore has been piling up on Chinese docks, government stockpiles of crude oil and grain are being expanded and stockpiles are being started for products like gasoline, diesel and sugar.”
China’s government presumably likes commodities in part because it believes in its own story — and, if you are bullish on China, conventional wisdom holds that you also should be bullish on commodities. China also hopes that its investments abroad will help to assure it a secure supply of the raw materials it needs. At the most basic level, the more investment in commodity production now, the lower the future price — and as a commodity importer, China would benefit from lower prices. And China could well view commodities as an inflation hedge.
That said, commodity price are volatile — so holding commodities is not devoid of risk. Buying the equity of commodity producers can be equally risky. And there is a long history that shows that investing in mineral production abroad is risky.
These though are risks that China seems to want to take right now.
Conversely, China doesn’t seem keen to take risk in the fixed income market. The old game of buying Agencies to get a bit more yield than Treasuries offer is over. And, I would guess — based on China’s comments about the importance of protecting the value of China’s investment in the US — that China also isn’t all that keen on the long-term bonds of large financial institutions. At least those that are not guaranteed by the FDIC.
China though doesn’t seem to have found a way to reduce its currency risk, despite all the recent talk. Probably because it is hard for a large country that pegs its currency tightly to the dollar to do so. China — per Bradsher — has found that it cannot buy gold without moving the market. That applies to currencies too.
Best that I can tell — see Figure 7 of the latest Setser/ Pandey paper on the management of China’s foreign portfolio — the United States’ share of China’s total portfolio has been fairly constant. The US data on its own suggests that China was moving out of dollars from mid-07 to mid-08,* and then moved back into dollars last fall. My best guess though is that the US data overstates both the move out of dollars from mid-07 to mid-08 and the move back into dollars in the fall. Rather than moving out of the dollar, China was moving out of Treasuries — and increasingly holding dollars in ways that the US data doesn’t pick up. Call it reaching for yield. After the crisis, China moved back into Treasuries — and started holding more of its dollars in ways captured by the US data. That at least is my best guess.
One thing to watch going forward: what China does if its reserve growth picks up again, and it has to put more money to work. For the past six months, China has essentially been reallocating its existing portfolio. Given China’s still large current account surplus, that was only possible because private money was leaving China. But if China ends up recovering faster than the rest of the world, capital inflows to China could easily resume … pushing China’s reserves back up.
* China’s recorded purchases of US assets from mid-07 to mid 08 are inferred primarily from the survey data. And the increase in China’s stock of Treasuries and Agencies was lower than I would have anticipated given the overall increase in China’s foreign assets. This period was also marked by large institutional changes in the way China manages its reserves - changes that potentially meant that the US data missed some of China’s holdings. For example, the CIC’s large holdings of dollar-denominated money market funds also did not appear in the survey data — likely because the CIC invested in “offshore” funds. Greater use of private managers and managed accounts will tend to lower recorded US holdings as well. There is also some uncertainty about the total scale of China’s foreign portfolio — which has an impact on the calculation of the United States share of the portfolio. I have compared China’s US holdings to its total foreign portfolio, not just to its reserves. That means that I am including the CIC and the PBoC’s other foreign assets and a (complicated) measure of the state banks foreign portfolio alongside China’s reserves."
Me:- bsetser responds:
don — you are right. the us didn’t want to do anything dramatic that china would consider an affront. like default on agencies.
but the us didn’t protect reserve primary (which china had invested in) from the fall out of LEH, and i would be quite surprised if SAFE didn’t hold some LEH and AIG bonds (LEH bonds weren’t made whole, obviously). The total amounts involved were small, but china in the crisis discovered that it is fundamentally loss adverse and the us gov didn’t protect it from all credit losses.
and then there is a rumor (unconfirmed) that china (via SAFE) may have had some of the agencies preferred stock (or something in the capital structure between debt and equity) and was surprised when that wasn’t protected. just a rumor tho.
as far as i know SAFE has never tried to explain in public why it shifted into agencies or why it shifted out … nor has it said anything in public about its little foray into equities. so i guess I am a bit less impressed by china’s public policy statements than you are!
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“Conversely, China doesn’t seem keen to take risk in the fixed income market. The old game of buying Agencies to get a bit more yield than Treasuries offer is over. And, I would guess — based on China’s comments about the importance of protecting the value of China’s investment in the US — that China also isn’t all that keen on the long-term bonds of large financial institutions. At least those that are not guaranteed by the FDIC.”
I’m still waiting for a good explanation of this. Even on the bonds of large financial institutions, it seems to me that the US didn’t like the idea of giving a big haircut to China.
Unlike most people, I find the Chinese explanations for their actions, especially on their website, to make sense and appear forward looking, especially when you set them up against most other governments in this crisis.