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China opinion divided on purchase of T-bills to prop up US economy

By Sean Maguire | March 27, 2009, Friday | Print Edition

AS China's economy slows, there is increasing focus on how it should manage its huge reserves of foreign currency.

China's near US$1.95 trillion in foreign reserves are with good reason viewed by many as its greatest strength - a bulwark against economic unpredictability.

However, within China opinion remains divided as some market observers question why the foreign reserves of a relatively poor country are being used to prop-up the economy of the world's richest.

American China watchers are accordingly sensitive to the vicissitudes of this debate within China. And so they should be.

There was a palpable note of anxiety in US Secretary of State Hilary Clinton's recent plea that China continue to purchase US debt.

The Chinese appetite for US Treasuries could pay a central role in determining the rates the US government has to pay for its rapidly accumulating debt pile, so the US government is understandably keen to stoke Chinese demands for these assets.

The US' principal argument is that continued purchase of these debt instruments by the Chinese authorities will help to jump start the US economy and thereby stimulate the import of Chinese goods -a win-win result.

There would be a global pay-off too: any deepening of ties between two of the world's three largest economies has to be a good thing.

Treasuries are relatively stable compared to other financial products, and if Chinese authorities wish to retain the majority of their huge holdings in liquid assets, there are few options that match the depth of the American bond market.

And if China didn't want to accumulate so many reserves, it would have to allow its currency to strengthen - the last thing the government would want to do at a time when the export markets are taking a battering.

It is well worth noting that if China did choose to reduce its holdings in US debt, others may follow suit, so leading to a weakening of the dollar and depreciation of dollar-denominated assets, all ultimately bruising to China's interests.

By retaining its current position in regard to the purchase of Treasuries, the Chinese government is increasing its political leverage.

As it accumulates more US debt, China is in a better position to persuade the US government to relax trade restrictions - to open its financial markets to more Chinese funds and remove barriers to the export of high-tech products to China, for instance.

Steepest tumble

But what if US Treasury bonds lose their value?

The US Fed announced last week that it was to buy up to US$300 billion in long-term Treasuries as part of a larger plan to pump US$1 trillion into the US economy.

The news sent yields on benchmark 10-year notes plunging to their steepest one-day tumble since 1987.

As interest rates hover around zero, central bankers are running out of options in their efforts to ease the strain on the credit markets, and quantitative easing is the only game in town.

The Chinese authorities, well aware of the risks associated with Treasuries in these turbulent times, are still at the table, but it remains to be seen how long they will want to continue playing while the US insists on using its own deck.

(The author is counsel of AllBright Law Offices in Shanghai. The views are his own. His e-mail: sbmaguire@allbrightlaw.com.)

Foreign Views


 

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