[Marxism] China's Wen Worries About Treasuries, Asks for Reassurance

[brad <bbauerly@xxxxxxxxx>]

  Sent to you by brad via Google Reader: China's Wen Worries About
Safety of Treasuries, Asks for Reassurance via naked capitalism by Yves
Smith on 3/12/09

Ooh, the posturing is getting interesting. As we noted in Links last
night, Timothy Geithner has already climbed down from his "currency
manipulator" saber rattling by pressing the G-7 to deliver a much more
China-friendly statement on what they'd like to see it do with the yuan
(the original version urged letting it appreciate. the watered down one
merely called for "a more flexible exchange rate".)

China seems to be pressing for advantage in advance of the upcoming
G-20 meetings. From Bloomberg:
China, the U.S. governmentâs largest creditor, is âworriedâ about its
holdings of Treasuries and wants assurances that the investment is
safe, Premier Wen Jiabao said.

âWe have lent a huge amount of money to the United States,â Wen said at
a press briefing in Beijing today after the annual meeting of the
legislature. âOf course we are concerned about the safety of our
assets. To be honest, I am a little bit worried. I request the U.S. to
maintain its good credit, to honor its promises and to guarantee the
safety of Chinaâs assets.â

China should seek to âfend off risksâ as it diversifies its $1.95
trillion in foreign-exchange reserves and will safeguard its own
interests, Wen said...

Delegates of Chinaâs legislative advisory body suggested that the
biggest foreign holder of U.S. debt diversify away from Treasuries into
more risky assets at the annual meeting that started on March 3.

Jesse Wang, executive vice president of China Investment Corp., said on
March 4 that his $200 billion sovereign wealth fund may invest in
âundervaluedâ commodity assets. Zhang Guobao, head of the National
Energy Administration, said China should invest more in commodities
instead of hoarding the U.S. dollar, the official Xinhua News Agency
reported on March 7.
Now on one level, this verges on silly. The problem is that the Chinese
carried a national strategy on blindly and are now stuck with
unforeseen consequences. Remember, in the wake of the 1997 Asian
crisis, the harsh IMF program imposed on Thailand and Indonesia left
spectators in the region resolving never to get in the position to
suffer a similar fate. The cause was hot money inflows, which led
currencies to rise. When it left, the currencies plummeted and
borrowers in foreign currencies suffered and often failed. The solution
was therefore to build up big foreign exchange reserves so as to fight
a sudden fall, which was done by pegging currencies cheap (which of
course also buffered them from a further decline). The choice of
Treasuries was by default, as the safest and most liquid place to park
funds.

And as much as buying hard assets like commodities sounds like a good
idea, those markets are small compared to the Treasury market. China
cannot deploy all that much there without distorting prices, which
would put it back at square zero, save buying underlying operations
(mines, agricultural land) rather than commodities themselves.

But China persisted with the strategy as it got hooked on export-led
growth. If it had bothered thinking about it, China HAD to know its
Treasury holding would be worth less down the road. It was pegging the
currency cheap, and when it eventually rose to a more normal level,
dollar holdings would be worth less. Perhaps the officials believed the
day of reckoning would never come.

But Wen is pointing at a completely different issue, that of the
ability of Uncle Sam to honor its debts. This would seem remarkable to
some until you consider the following:
Moody's warned of the risk of a US downgrade in the next 10 years
BEFORE all the emergency expenditures and financial firm emergency
operations started

Standard and Poor's said consolidation of Freddie and Fannie might
impair the US's rating (um, we aren't going to let them go, so the
distinction between consolidation and what we have now looks largely
cosmetic).

Credit default swaps on US 5 year debt, last I saw, was 100 basis
points. Not all that long ago, it was 2, assuming you could even get a
quote, the idea of a CDS on govvies seemed ludicrous. The US now seen
as far from a risk free credit
And in case you think the credit risk is exaggerated, consider. The US
already partially defaulted on its debt.

Recall how Bretton Woods operated. Rather than go back to a gold
standard at the end of World War II (its defect is a deflationary bias,
which made the Great Depression worse), the US instead pegged its
currency at $35 an ounce and other countries set rates of conversion in
dollar or pound sterling terms. By 1965, the value of dollar claims by
foreigners on America's gold reserves at the $35/oz. rate were greater
than the actual supply. The US defaulted on its $35 par value when
Nixon cancelled Bretton Woods by suspending the convertibility of
dollars into gold. As Michael Hudson noted (hat tip reader Rajiv):
The $75 billion that the U.S. Treasury [would owe] to the worldâs
central banks at 1968â1972 prices and exchangeârates would be repaid
with the equivalent of perhaps less than $40 billion in purchasing
power as measured by the original debt. To the extent that gold was
revalued and part of this $75 billion repaid in bullion, the gold
tonnage price of this dollar borrowing would be written down to less
than oneâfifth of its original value as measured by the yearâend 1974
price of almost $200 an ounce
And if you don't buy the gold valuation (remember, it had been the
value peg until broken), consider that the resulting floating rate
regime saw a big depreciation of the greenback against most major
currencies.

In other words, the idea of a US partial default is far from a loony
line of conversation; we did it less than 40 years ago.

And in light of that history, why is Wen asking for assurances? None
can be made. So what concession might he be looking to extract instead?
Now that China's trade surpluses have fallen sharply, it has no
particular reason to buy Treasuries at anything like its recent volumes.

As we said, this message is most likely to be posturing for domestic
consumption, but China could also be putting stakes in the ground.
Watch for the next move in this gambit.
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