Thursday, February 12, 2009

The China-Treasury Bubble?

It's dangerous for a self-styled market-timer like me to prognosticate about things as complicated as international trade and the global economy, but my gut reaction to this article in the Financial Times was too strong to ignore:
China to stick with US Bonds

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. However, the increasing US budget deficit and its potential impact on the dollar have raised questions about the future Chinese appetite for US debt.

Luo Ping, a director-general at the China Banking Regulatory Commission, said after a speech in New York on Wednesday that China would continue to buy Treasuries in spite of its misgivings about US finances. “Except for US Treasuries, what can you hold?” he asked. “Gold? You don’t hold Japanese government bonds or UK bonds. US Treasuries are the safe haven. For everyone, including China, it is the only option.”

The not-so-subtle message here is that China buys US Treasury Bonds, not so much because it wants to, but because it has to. The fact that it's even being discussed means that there is some doubt that China will always be willing to buy them in the future.

My crude understanding of trade between the US and China goes something like this:

  • The US buys manufactured goods from China with US dollars. (more than $300 billion worth in 2008)
  • China uses a small fraction of those dollars to buy goods, raw materials, etc. from the US. (only $70 billion in 2008)
  • China uses the dollar surplus to make investments in the US, including buying US Treasury bonds.
A Treasury bond is simply a promise by the US government to make future interest payments to the holder ... in dollars. So when China uses excess dollars to buy bonds, they're simply replacing dollars today with more dollars next year.

Here's my question: Doesn't China already have more dollars than it knows what to do with? If the Chinese can't find anything else to buy with hundreds of billions of dollars today, what makes them think they'll find something to buy next year or next decade with even more dollars?

It smells like a bubble to me. Granted, I'm sure there's some macro-economic logic behind what China's doing, such as maintaining stable exchange rates, but that doesn't mean that the current strategy will work forever. I can't think of any system for which too much of something today is solved by getting even more of it in the future.

In other news:

- The S&P 500 broke through the lower trend line this morning. There may be more on that later.

- GRZZX rose 6.1% on Tuesday (Feb. 10), the same day that the S&P fell 4.8%. I would be perfectly happy if GRZZX only moved 1-to-1 with the S&P, or even only half that rate, but I'm very pleased indeed when it actually outperforms the inverse.

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