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