Wen’s U.S. posturing doesn’t matter – yet

March 18, 2009

James Saft Great Debate – James Saft is a Reuters columnist. The opinions expressed are his own –

What is more remarkable, that the premier of America’s largest creditor publicly raised concerns about U.S. creditworthiness or that the market took the news so easily in its stride?

“We have lent a massive amount of capital to the United States, and of course we are concerned about the security of our assets,” Chinese premier Wen Jiabao said on Friday at a news conference to close the annual session of parliament.

“To speak truthfully, I do indeed have some worries. I would like, through you, to once again request America to maintain their creditworthiness, keep their promise and guarantee the safety of Chinese assets.”

Can’t be blunter than that; the Creditor-in-Chief at the top of the country whose foreign reserves include about $1.4 trillion of U.S. dollar assets is now fretting that he won’t get his money back and is talking about “promises” and “guarantees.”

Besides pointing out that there was very little of this kind of talk when Americans were stuffing their garages to the rafters with Chinese goods in 2006 and before, it is just amazing how little impact his words seem to have had.

U.S. Treasuries fell on the news, but not sharply and much of their moves throughout the rest of the day were driven more by the ups and downs of the stock market, which ended its best week since November with another day of gains.

So I offer two possible reasons why Wen’s warning was so little heeded:

First, he’s not telling us anything we don’t already know.

The U.S. is a worse credit than it used to be, and likely to deteriorate still, especially for people taking currency risk. The cost of insuring the U.S. against default over five years has risen to about 80 bps, up from just 0.6 basis points in January 2007. And that is insurance that might prove mighty hard to collect on if the U.S. were actually to go bust, seeing it would take just about every counterparty in the world down along with it.

There is just no doubt that the aggressive monetary and fiscal policies the U.S. is pursuing, while perhaps appropriate, raise the risk to creditors that they see the value of their debts inflated away from them or eroded by a fall in the value of the dollar, or both.

CHINA’S UNAPPETIZING ALTERNATIVES

Secondly, even if Wen’s analysis is correct, he’s pretty much stuck as a passenger at this point. He has very little ability or willingness to do much about his U.S. credit exposure without hammering his own fingers in the process.

After all, if China cuts back radically on Treasury purchases the dollar will go into a spiral and the new higher interest rates the U.S. will be forced to pay to finance its spreading bailout will rise, giving China a rather ugly mark-to-market issue of its very own. God help them both if China actually starts selling.

And even if it does take the hard decision to aggressively diversify, what on earth is China going to buy instead and in massive size? European debt? At least no one is talking about Florida eventually seceding from the Union. And I’m not even going to start talking about Japan.

Or what about Switzerland? It always seems like a sober country, a safe haven in times of stress. Sorry, it has now embarked on a campaign of quantitative easing and is buying up foreign assets to drive the value of their own currency down. It may be however, that China is losing hope of the U.S. bouncing back strongly asa consumer of its goods and now realizes that its bread is buttered more as an investor than supplier.

None of this is to say that the message from Wen wasn’t taken seriously in Washington.

“Not just the Chinese government, but every investor can have absolute confidence in the soundness of investments in the United States,” U.S. president Barack Obama said at the weekend.

And indeed the quantitative and qualitative easing now going on in the U.S., Britain and Switzerland should scare creditors witless. The U.S. isn’t going to default but that does not mean that its lenders will count themselves satisfied in five or ten years’ time.

As for China, it may have other worries than simply its Treasury holdings. It also holds about half a billion in debt issued by Fannie Mae and Freddie Mac, now in U.S. conservatorship. China is thought to have scaled back sharply on these purchases when the two were taken under the government’s wing but their debt not made an explicit full faith and credit obligation of the U.S.

So, China and the U.S. are joined at the hip. The interesting bit will be seeing how China reacts if the dollar starts falling or inflation gets out of hand. They won’t start this fire, but they may add to it.

– At the time of publication James Saft did not own any direct investments in securities mentioned in this article. He may be an owner indirectly as an investor in a fund –

36 comments

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Good column, I thought. Brought things together.

Posted by Pete Cann | Report as abusive

The US will continue to issue fresh debt to pay off older Debts as long as Buyers exist for those securities. Meanwhile the US Government continues the quantitative easing and bale outs going by running the Currency Press at full capacity. Trying to inflate your way out of trouble will give very short term returns but the end result is a foregone conclusion – a fall in the value of the Dollar or Hyper Inflation. I cant see the possibility for any other outcome.China may not intentionally want to rock the American boat but the possibility of differences arising elsewhere and souring relations cannot be written off. Till such time the PARTY continues.

Posted by F.Daruwala | Report as abusive

James you are correct again. At some point the Chinese will come to realize that the U.S. market will no longer consume like it did before the recession (depression) even if there is any recovery at all. Mark Panzner the author of “When Giants Fall” put it succinctly, “China is the 800 lb gorilla in the room”. At some point in time the Chinese government will decide whether or not continuing to hold U.S. debt is in their best interest. Everyone else will follow. It should be of note that the Eu, Australia, China and others are scrutinizing and restricting foreign imports and investment. I expect this trend to widen as it continues.

Posted by Anubis | Report as abusive

China will soon discover the wisdom of the late 18th Century Economist David Ricardo: “Finance is a conspiracy against the laity.”

Posted by John P. Crowley | Report as abusive

I would like to take the time to officially welcome to the world of high finance. What did you think you were doing in accumulating so much US debt so rapidly?Perhaps in the beginning, it was thought that China might gain some leverage over US efforts to get China to allow the yuan to float more freely on currency markets. The yuan was in fact allowed to float over a very narrow range, although it almost immediately appreciated to the top end of the allowable range.Domestically, China needs to add 20 million jobs per year just to absorb new entrants into its work force and maintain stability, but at the same time news media continually reported Chinese efforts to keep a lid on the growth (8-10% growth good, 14% growth bad) to avoid inflationary pressures.Meanwhile, China’s government held it’s bank lending rate at 5.3% for NINE YEARS. Needless to say, this caused problems as China started to experience it’s own housing bubble. In most economies, Prime Lending Rates tend to track economic growth very closely, but in China the spread was anywhere from 3-5%. Obviously their economy was overheated and their currency undervalued.In 2001 China held US$215 billion in FER. Near the end of 2007 that had grown to $1.4 trillion. It is no coincidence that this follows the U.S. budgetary trend of running up massive fiscal deficits over the same period, and almost the same amount of money the US has spent to date to finance foreign adventures.All China had to do to cool it’s economy a little was stop buying every US Treasury Bill it could get it’s hands on. Now China is irrevocably tied to the fortunes of the US.Sources:http://fpc.state.gov/document s/organization/99496.pdfhttp://gbr.peppe rdine.edu/052/hottopic.html

Posted by Robert Pratt | Report as abusive

The world has been wise to be wary of China since it was known as Partha. Their ethos is this: why buy it if you can steal it. They are massive thieves of intellectual property and military intelligence and material. They spy openly on our Government and Businesses. And we allow them this obscene imbalance of trade, and abuse of power because they pay cash for our Bonds. They are not good business partners.The US government would be well served to do business with fair and lawful brokers, who have some semblance of shared values.

Fed chief Bernanke was on the news magazine 60 min in an unprecedented interview where he described increasing the amount of money available to loan the beleaguered financial institutions as making a few keystrokes on a computer. Everyone likens the expansion of the Fed balance sheet as ‘printing money’. But they don’t even have to do this anymore, they send a command to a computer database that says we now have this much money and the send and electronic funds transfer to the counterparties to the loans after the arrangement is final. US currency (and I have to suspect that currency around the world) is now not backed by anything at all in reality. Currency is now just some electrons moving through a vast information system. The side effects of this, as I understand it, are inevitably inflation. The only way to combat this is to inflate everyone’s currency, so we all stay relatively speaking the same. How long this game of musical chairs can continue is anyone’s bet. But this sounds eerily similar to some excerpts I have read about the aftermath of the 1929 stock market crash. Apparently, no one has learned from history. America is already broke, but since the US dollar is the fiat currency, no one dares call in their bets because it would collapse the entire world economy. If anyone expects the US consumer to pull the world economy back from the brink, don’t hold your breath. 1 in 8 homeowners owe more (or paid more cash for) on their house than it is worth. Millions of Americans are about to lose their homes, which will destroy their credit for 7 to 10 years. People still with houses and jobs (jobs which are evaporating everyday) are maxed out on debt. And if you are lucky enough or smart enough to have avoided all these pitfalls, you are going to get hit with record taxes, pay cuts or income stagnation while being expected to do more for your employer. This economy will NEVER be the same again, of that I am certain.

Posted by J | Report as abusive

Foreign investors have got burned more than once in the US, most recently with the internet bubble burst and CDOs. Most of the high yield US investment schemes (Madoff’s just gone sour faster than others)look more like Ponzi schemes. Treasuries are no exception. The China-US deal was a different one – you buy our goodies, we buy your debt paper. If one side of the deal is not honored, the other one may well not be honored as well. Chinese kept investing in US debt probably because it was indeed a high-yield investment until recently with Treasuries value rising. But they should have been selling rather than buying in the end of last year as there is no way Treasuries would go up. The losses on US debt can be spectacular with some people suggesting that if yields go up to their avearge of about 4 to 5% China could lose as much as 120 billion USD. So they probably would not be able to sell it, when they need cash, without a loss. So it is not just about defaults, it is about the value of your investments being protected, which is the greatest concern. I understand that Russian Central Bank indeed realized some hefty gains by selling US debt while supproting the Ruble.

Posted by dv | Report as abusive

If the Chinese should decide some day to get rid at once ofall their US treasury bonds and other US dollar denominatedassets, then the US government, the US economy, as well asthe US dollar would suffer an immediate and unrecoverablecollapse.

Posted by Steve | Report as abusive

Dear Mr. Saft,The U.S. is already experiencing a deterioration in both the quality and size of foreign cash inflows – see Brad Setser’s blog at the Council on Foreign Relations at: http://blogs.cfr.org/setser/2009/03/18/a -bit-more-to-worry-about-foreign-demand- for-long-term-treasuries-has-faded/The quality and size of China’s purchases of U.S. debt have deteriorated significantly. Foreign investors are piling into short-dated Treasuries only – this is a worrisome trend, because it potentially signifies that demand for the dollar as a safe haven, beyond merely the very short term, may be collapsing at a time when the U.S. desperately needs global investors to step up and buy, and hold onto, its sovereign debt. Thus, the outlook for Treasuries is significantly deteriorating. The price declines/yield rises on the 10, 20 and 30-year Treasuries we’ve seen this year confirm this fact, and establish the negative trend.I must admit, I’m getting quite tired of hearing analysts and experts parroting the idea that China is stuck with buying U.S. debt and has nowhere else to go. That extremely popular notion simply doesn’t square with the facts. China’s resource buys demonstrate that it doesn’t believe the popular notion either. These are being used by China’s central bank to decrease its exposure to the dollar. Please see my 3-part article at Asia Times, entitled “Dollar Crisis in the Making”, at: http://www.atimes.com/atimes/China_Busin ess/KC18Cb01.htmlwhere I detail how China’s central bank is inoculating itself against a dollar crisis.

All this looks like a receipe for a nice War. There are hardly any other options remaining.

Posted by Pessimist | Report as abusive

3 out of 4 families came thru the great depression ok.with sacrifices, yes, but still ok.our goals- as individuals- are simple.either be in the 3 out of 4 who will do okin this depression….ORget a government bailout.I wouldn’t mind getting a $150 billion bailout,and i have better credit than AIG or CitiCorp.

Posted by d. d. kelman | Report as abusive

The inherent tension in the China-US relationship are likely to prove interesting at a number of levels. In this instance, I think, we are simply seeing in Wen Jiabao’s statement an explicit acknowledgement of what is, of course, widely understood. What’s interesting is that he chose to make such an explicit statement, preceding forthcoming G20 festivities, and that the US was, of course, as I assume the Chinese government expected, compelled to issue forceful yet compliant verbiage. As such, the exercise marked a further evolution in the relationship in which China is moving toward further and more forcefully asserting its economic dominance, which is historically appropriate, and the US edging, while issuing ‘strong’ rhetoric, toward acknowledging its diminished ability to attempt to assert dominance. It’s a relatively subtle game, with the critical text–obviously–clear but not explicitly stated as is traditional in statecraft. In a sense, while the Chinese are very much concerned as to the realities with respect to the debt and currency issues, these are clearly if not explicitly subsidiary to the relationship with respect to the projection and exercise of power. This is the way the game is, this is the way the game is played, from whatever may have constituted the ‘birth’ of the species homo sapiens to whatever its future may be.Nice piece, as always, my thanks.

Posted by atomikweasel | Report as abusive

Dear Mr. Saft, is there anything bright, optimistic that you can tell us ?

Posted by Mario | Report as abusive

pheonix1- Hmmmm where to start, I don’t know which planet are you from but all the other countries including US do the same type of spying. Hopefully, this is not news but US is actually the worst business partner compared with many other countries. Fairness and ethnics…does Walmart, ring a bell. Why is most the things made in China? Big US companies wants to make a larger profit so they hire cheap labor in 3rd world countries. Third world countries benefits solely from cheap labor working $1-2/hr. The product is sold back to the US at 10-20x it’s price.Another thing is without China buying all of our bonds, etc. US would be bankrupt and $ would worth nata. You do know that we are in a deficient. We are trillions of dollars in deficient, and if China discover that US no longer investment worthy it’s pretty much over.Lets just say in a another decade or two, learning to speak Mandarin will be a greater asset than English.

Posted by Yo | Report as abusive

If you were in China holding $1.3 trillion of unsaleable USA treasury paper, listening to Liddy saying AIG payouts were necessary to retain top employees with the specialized knowledge to dispose of $2.7 trillion in complex securities — after all they had the specialized knowledge to ACQUIRE that same paper, most of now in China — then Hillary shows up wanting to issue more funny money to pay for those bonuses, how would you react?

Posted by N.O. Wiser | Report as abusive

The U.S. needs healthy growth to service it’s debt in the future, and that isn’t going to happen for a number of reasons including, a shrinking workforce with the retirement boom, tapped out effects from globalisation,and the strangling effects of commodity inflation in the event of robust global growth.Since growth is going to be anemic at best the U.S. will reach the point where it seems it exists to service debt. Combine this with has always been a pridefull go-it-alone attitude, and the I believe the chances of default are very good. The argument lies in wait too that the U.S. has been a victim, the trade deficit, (an underlying reason for those huge foriegn reserves), created by countries who have manipulated their currencies to keep them artificially low.The only way I don’t see default is if large holders of U.S. debt, China, Japan, and the Saudis, decide to roll over the debt to avoid the potential catastrophe default means.

China warning the USA to ensure the security of their assets is a very sick joke. The very same assets that they “earned” by manipulating their currency and pegging it against the US Dollar, substantially subsidizing exports into the USA, undercutting the US labor force and manipulating the migration of US jobs off-shore into their country. They have been engaged in substantial uncompetitive behaviour for a long time and they must now be managed.What the Chinese don’t say overtly, is that they have been waging an all-out strategic economic war against the USA for quite a while. Their centralized government has a very carefully planned strategy that is geared around the long term weakening of the USA’s industrial infrastructure. They have intentionally targetting sectors of the US economy for closure, stealing intellectual property, counterfeiting US manufactured goods, subverting brand names and raping the US consumer with low cost poor quality products.I challenge anyone to find competant US manufacturers to replace those Chinese manufacturers that now make products that the US consumers use. Technical know-how has dissappeared from the USA. Whole industry sectors have all but dissappeared, and much of the production infrastructure ahs been dismantled and shipped off to China. In addition, US investors have lost their appetite for the risks involved to compete with their off-shore competitors due to playing fields that are so far out of level, it is frightening!They are now pressurizing the US to remain engaged and protect “their” investment in the USA, while at the same time hording resources, manipulating mineral and raw material resources internationally.The very best course of action that all US manufacturers can take is to diversify away from China into other economies including re-energizing manufacturing in the USA. This is going to take a very consistent and carfeully implimented strategy by the US government and US industry.It is time the US Federal and State governments structured a coherent startegy to re-industrialize the USA once again to be world competitive, not just pay lip service to it!

Posted by Stuart | Report as abusive

In the crisis as profound as we have on hand somebody’s got to lose. To save US economy from total collapse the Fed can do only one thing – create money out of thin air and throw it at the next hole in financial system hoping to plug it, which it does with varied success. It would be naive not to expect inflation as a result. And that means that the pile of US $ amassed by the Chinese and some other entities abroad will be worth less. But making the Chinese whole isn’t, and should not be, at the top of the Fed priorities list.

Posted by Anonymous | Report as abusive

Consider that there is another alternative. Even though things haven’t gone there yet, China is actively building it’s military. And it is becoming more aggressive in its air and sea patrols.When economies start going south, war is one way to get production up and put people back to work. There may not be much the Chinese can do on the economic front. But the US military is quite over extended at present. Global economic conditions like these are a tinder box for war. It would perhaps be wise to keep an eye on China’s military.

This blog so far, has provided some VERY disturbing incites into our future…I’m Holding onto my Gold and Silver. They may be one of the few things left worth bartering and if the Dollar tanks it would provide some Inflation security.

Posted by Joseph W. | Report as abusive

I have come to the conclusion that James Saft wants our country to collapse. I have never seen so much negative journalism coming from one guy over and over. It’s as if this guy gets a smile on his face when bad economic news is released.

Posted by Andrew Manc | Report as abusive

The Chinese premier is less concerned about its investment in the U.S. than providing a veiled threat. He’s telling us his country could bankrupt our nation by calling in its chips. This is diplomacy talking, not genuine business concerns. China wants to discourage us from backing its “breakaway province” Taiwan. It is flexing its muscles by building a powerful navy and overall military. It definitely plans to build a very strong presence in Asia and wants us to stay hands off in that area. China’s leaders have been known to boast that, while calling in their US investments would also hurt China, it could survive the fallout better than the US in their long view.

Mr. Saft has finally offered a valid ‘tip of the iceberg’ view of what is in store for the world’s economy. Although he still cannot grasp the full size and scope of it.In teaching economics, I have for years been saying that the US is on the way towards third-world status. For the most part I was ‘over-stating’ to make a point to my students. Now I’m not so sure my over-statements were that far off, and it scares me. And if it scares a nobody like me, then its no wonder that smart people like Wen JiaBao would also take pause to ponder this question.Dig deeper Mr. Saft, you might uncover much more….

Posted by Jim | Report as abusive

In some respects, the USA may go the way of the USSR during the Breshnev 80s. Declining industrial and commercial competitiveness, due to vested interests, risky military expansion dominating investment, corrupt politics, …Then what ?

Posted by Survivor? | Report as abusive

I had a fortune cookie the other day from China, it said,’Wise man plants rice in fertile ground and if its yield becomes poor with weather he will sell you into submission until you yankee dog learn who is big boss China.’Your lucky numbers are 1, 7, 42, 19, pearl harbor was nothing you deadbeat yankee dog, 22, 67 & 9I did also buy an American Flag T-Shirt which read,Made in ChinaWe own you nowYankee Dog

The 401k party that started in 1982 is finally over and with it the housing boom (which btw also started in 1982)…

Posted by Patrick Gander | Report as abusive

I would be perplexed as a foreign lender. On one hand we see plans for massive spending. On the other hand the government is clearing its longterm debt presumably at market prices. I can’t figure out what is happening. Is more debt being floated short-term to clear long-term? By providing liquidity to holders of long-term debts, it seems like we are gobbling up all the available liquidity on the short-term side. I just don’t understand what in the world people are trying to do. I’m beginning to realize how this mess developed in the first place. It’s because the U.S. treasury is managed by dimwits.

Wait a minute — if you want to dig deep, maybe Jon Steward really is on to something with Cramer. Did you see the clips on market manipulation. Heck, this type of reality is getting to be a lot more interesting than the TV reality shows….

Posted by I.M. Alright | Report as abusive

The old lyric out of the song “Big Bad John” was “I sold my soul to the company store”. Well, us Americans have sure sold our souls away. All for the sake of bunch of WalMart materialism that will eventually end up in landfills. And the Chinese? They get all of our funny money…. Whoopee!!!!

Posted by Juanny Waymond | Report as abusive

As a private citizen involved in neither banking or property developing, it is my fervent hope that when (or is that if) this awful economic episode is over, that the elected politicians of democratic countries remember that they are not elected just to represent bankers and property developers.I’m certain that banking and property developing is at the root of the problems and the politicians, especially Tony Blair, fertilised the problem instead of applying weed killer.

Posted by Peter H | Report as abusive

I forgot to add to my comment that commenters like Andrew Manc shouldn’t really be shooting the piano player… the bad economic news coming out of America probably wasn’t perpetrated by James Saft (a truly insightful journalist), but by people like Tony Blair, Bill Clinton and George W Bush. Shoot the chief not the little people.

Posted by Peter H | Report as abusive

Peter H writes: “… it is my fervent hope that when (or is that if) this awful economic episode is over, that the elected politicians of democratic countries remember that they are not elected just to represent bankers …”I think that they will not remember anything if their constituents do not remind them of their duty, i.e. to remember the present calamities, DAILY !!!

Posted by DAR | Report as abusive

I am currently sitting at a desk, looking out at the sunshine in Shanghai. I arrived by airplane 2 days ago and noticed that at rush hour, the traffic was not so rushed and the pollution is not so polluting. I could breath some fresh air.While office rents have declined and housing costs have declined and ex-pats are forced to find cheaper digs, I find nothing but opportunity.I am sorry more people cannot find some optimism. I find Mr. Saft’s journalism to be provocative. The politicians need to listen more and think about what they are doing, instead of trying to be noticed by some voters. We may not like this situation, but China aand the US are joined at the hip. We did it to ourselves. Get used to it. Thank you….Mr. Saft.

Posted by Ronald Buatte | Report as abusive

Wen’s does seem to be making a threat. Since his comments came only days after the latest Chinese Navy/US Navy incident. China is flexing nuts, hopefully Obama doesn’t back down, because the US has some mighty big nuts as well. As far as status quo going forward China needs us as much as we need them, although I believe it would be far easier for the US to recover from China pulling out stakes and come out on top in the end.The vaunted China million man army would need a lot of transport to cross the Pacific, and that’s a mighty large shooting gallery so if it got really bad it would probably come down to launching nukes. Not much profit there, until someone finds a way, then we are really all screwed.

Posted by Chris | Report as abusive

http://yourusdebate.blogspot.com/Join Us, Debate to prove your party is better!

Posted by Your U.S. Debate | Report as abusive