Monday, May 18, 2009

They are obviously buying U.S. Treasury bonds for the purpose of sustaining their export market in the United States

From The American Prospect:

"When China Buys U.S. Bonds It Is Manipulating Its Currency

The folks who couldn't see an $8 trillion housing bubble are now busy spreading another absurd untruth, that the United States needs China to buy its Treasury bonds to keep down interest rates. This is completely untrue and in fact runs against the stated goal of both the Bush and Obama administration of a higher-valued Chinese currency.

This should all be very straightforward. When China "manipulates" its currency (there isn't much secret here, the government openly manages its exchange rate) it buys up U.S. dollars. That is the way currency markets work. China's huge trade surplus would otherwise cause the value of its currency to rise against the dollar. However, China has an explicit policy of preventing this rise by using its foreign exchange earnings to buy dollar denominated assets. One of the dollar denominated assets it buys is Treasury bills.

If China stopped buying dollar assets (including Treasury bills), then the dollar would fall against China's currency. This would make Chinese imports more expensive to people in the United States (just like a tariff) and we would buy less of them. It would also make U.S. exports cheaper for people in China, causing them to buy more of our exports. This improvement in the trade deficit would help to stimulate the U.S. economy, which is one reason that many people have advocated reducing the value of the U.S. currency relative to the yuan.

China could continue to buy U.S. currency (thereby keeping down the value of its own currency) and just buy short-term deposits, rather than Treasury bills. This would cause long-term rates in the United States to rise other things equal. However, there is no reason to assume that other things would be equal.

The Federal Reserve Board could step in to buy more long-term bonds to offset the lower demand for China. It is no more inflationary for the Fed to buy enough bonds to keep the 10-year Treasury rate at a low level (say 3.0 percent) than it is for China to buy enough 10-year Treasury bonds to keep the interest rate at 3.0 percent. It is simply not true that we need China to buy our Treasury bonds.

Finally, China is not buying these bonds as an investment. It absolutely will lose money on these bonds.The dollar will fall and interest rates will rise. This makes U.S. Treasury bonds a really bad investment for the Chinese compared to say, buying short-term euro assets or almost anything else in the world. They are obviously buying U.S. Treasury bonds for the purpose of sustaining their export market in the United States. This is not an accidental outcome of their actions.

[I see that Paul Krugman has made the same point.]

--Dean Baker


The one place that I disagree with you is on the flight from agencies to treasuries. It seems to me that this has to do with the fact that the govt did not explicitly guarantee agencies after Fannie/Freddie. The Chinese claimed two things:

1) They operated on the same set of implicit guarantees as did our large banks and investment firms, and, like them, expected them to be honored.
2) To not guarantee their assets but to guarantee US assets was protectionism.

This flight was very bad indeed because it contributed to the scare of debt-deflation. I just don't see the timing, effects, and assumptions of the flight being totally concerned with exports.

Posted by: Don the libertarian Democrat

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