Can the Chinese really dump their treasuries?
March 15, 2009
Seems like a day doesn’t go by without a reporter asking someone whether they think there is any danger of the Chinese not buying our debt any more. This week their Premier actually voiced ‘concerns’ and everyone took notice.
But can they? I don’t see how. Am I missing something here?
The way I see it, they have to for as long as we continue to have a large trade deficit. In 2008 we exported 71 billion worth of goods and services to China, and imported 338 billion. That means they ended up with 266 billion dollars (all the money we gave them in exchange for TVs and other trinkets, minus the money they gave back to us to buy turbines and heavy machinery). Part of that money goes to buying raw materials, but most of it they keep.
What they do with these dollars is put them into some sort of interest-bearing but very safe vehicle, mostly Treasuries and Fannie/Freddie bonds. Recently they had even started experimenting with riskier things, famously investing 3 billion on Blackstone in May ’07.
So what could China do with the dollars it has and continues to accumulate?
- Sell them and keep cash instead: This would remove whatever risk of default, at the cost of producing a negative return (after inflation). And there would still be the much larger risk of a dramatic fall in the price of the dollar.
- Exchange them for local currency: Selling dollars is not what they do. In fact they’ve been buying 50 billion per month to keep the dollar high and the yuan low. If they stop doing this the yuan will appreciate, which will make their products more expensive to us and lower demand for them. Never mind that Washington has been trying to get them to do this for 5 years, it would slow down their growth.
- Invest in other countries’ debt: The U.S. is still the safest place to park your money, with its comparatively good governance, powerful army and dollar as trading currency for oil and raw materials worldwide. Additionally, exchanging their dollars into Euros, Rubles and Riyals will depress the dollar, lowering the value of their remaining assets and boosting American exports while slowing their own.
- Diversify: China already has a considerable real estate investment in the U.S. via their GSE holdings. Hedge funds and private equity is probably too risky and opaque. And how many large American corporations can they find to sink hundreds of billions of dollars into without running into regulation snafus like the failed Unocal purchase.
Instead my fear is long-term: When China decides it has developed enough technologically and has brought enough of its population into productivity, they can decide overnight to drastically raise standards of living (lowering taxes on middle class, making credit available, subsidizing cars and housing, etc.) and turn their workforce into consumers. The moment they do this they won’t need us anymore, and they will be free to dump their dollar-denominated assets, striking a deadly blow to the dollar and acquiring incredible ownership and control beyond their shores.
This is not possible now, but it could be in a decade or two.