One of the best illustrations of hyperbole regarding China in some financial circles is the disingenuous belief that the PBoC, SAFE, CITIC and other Chinese agencies could use a mythical financial “nuclear” weapon by selling all of their US treasuries at one time — which in their RDF-minds would somehow decimate the US bond market.
And while I am hardly bedfellows with the Pentagon, some analysts at the DoD put together a well-reasoned bucket of cold water to throw on the faces of hysterics this election cycle.
Below are quotes from a thorough Bloomberg report (which is still blocked out here) regarding the DoD analysis:
China’s holdings of more than $1 trillion in U.S. debt and the prospect that it might “suddenly and significantly” withdraw funds don’t pose a national security threat, according to a first-ever Pentagon assessment.
“China has few attractive options for investing the bulk of its large foreign exchange holdings out of U.S. Treasury securities,” given their extent, according to the report dated July 20 and obtained by Bloomberg News.
“Attempting to use U.S. Treasury securities as a coercive tool would have limited effect and likely would do more harm to China than to the United States,” according to the report, which was sent to congressional committees by Defense Secretary Leon Panetta. “As the threat is not credible and the effect would be limited even if carried out, it does not offer China deterrence options” in a diplomatic, economic or military situation, the Pentagon found.
The Chinese “are very astute money managers and they would recognize that the damage of doing that would have negative consequences for them and for global trade, which is already in a difficult place,” Ader said in an interview.
“In fact, the Chinese are acting out of their own self- interest,” Morrison said in an e-mail. “They have to buy U.S. dollar assets as long as they are intervening in currency markets to hold down the value of the RMB against the dollar,” he said, referring to China’s currency, the renminbi.
A sudden and large reduction of China’s holdings “could cause short-term” secondary market disruptions and interest- rate increases for Treasury debt issues, according to the Pentagon report.
It also “would impose significant costs on China,” as the supply of U.S. Treasuries increased and the value of China’s holdings fell sharply, the Pentagon found.
Ira Jersey, an interest-rate strategist at Credit Suisse Group AG in New York, one of 21 primary dealers that trade directly with the Fed, said other buyers would step in if China eliminated or reduced its U.S. holdings.
“In an environment like today, if Treasuries were to sell off 50 basis points in the 10-year sector, you’d see a lot of demand from domestic and non-traditional foreign investors, including other central banks, which would step in to purchase at lower prices and somewhat higher yields,” Jersey said. A basis point is 0.01 percentage point.
The Pentagon said in its report that the Fed also is “fully capable of purchasing U.S. Treasuries dumped” by China and “reducing the economic impact.”
Again, the Federal Reserve and oodles of other non-governmental organizations, banks and institutions could easily step in and buy the notes without much of a blip. And any asset the Chinese buy will necessarily increase in value — thus costing them more. Over the past several years there have been a few officials at SAFE and PBoC that have publicly discussed this issue — they are aware that they are stuck between a rock and a hard place.
And on that note
Since we have now broached the topic of what country is really reliant on the other, China depends much more on the US than the US does China. The US exports substantial amounts of agricultural products to China whereas Chinese manufacturers are heavily dependent on US consumers.
There is also so much subsidization at all levels of the exporting industry along Chinese coastal provinces at the detriment of the domestic consumer/resident (exporters receive preferential tax breaks and many manufacturers also receive preferential loan treatment, which must be paid by someone). This is hardly a new discovery either, see this 2007 story from the NYT for one example.
In fact, one reason the PBoC and SAFE continue to buy and hold treasuries, as the Bloomberg report notes, is to maintain their yuan peg (to the detriment of the Chinese importer). And they are not floating it anytime soon. In fact, the yuan has depreciated relative to the USD over the past 6 months to help exporters (1 2 3).
On a tangential note, while the US solar panel lobby has won regulatory capture (if you thought Solyndra was bad, US manufacturers convinced policy makers to impose duties on Chinese-made solar panels increasing the costs to consumers), the same thing has occurred in Guangdong and Zhejiang with manufacturers that lobby and bribe (hong bao) Party members in Beijing. Also, not to justify the ridiculous duties placed on Chinese solar panels, but the Chinese solar panel industry is also heavily subsidized and assisted. See also this good overview from Reason.