Feeds: 
symbol identifies content for paid subscribers only.
Why Is China's Prime Minister Complaining About the Risk of Holding U.S. Government Bonds?
By all accounts China's Prime Minister, Wen Jiabao, is an intelligent man. Therefore he knows that China will lose a substantial portion of its investment in U.S. Treasury bonds. This raises the question of why he is complaining about the risks in China's holding of U.S. Treasury bonds, when he knows that there is no risk, the investment is a sure loser.
The loss will come for two reasons.
First, the United States is running a large trade deficit. The only way that this surplus can be sustained is if the Chinese government and other central banks continue to buy up ever more U.S. dollars, thereby preventing the currency from falling. If the Chinese government ever stops buying vast amounts of U.S. dollars, the dollar will fall in value against other currencies (as it did in the years 2002-2007) causing China large losses on its holdings.
But, this loss is China's decision, not the result of U.S. government policy. As long as China wants to spend hundreds of billions of dollars each year propping up the dollar, it can prevent losses on its prior holdings due to a fall in the value of the dollar, but there would be no reason for Mr. Wen to complain about a policy that he or his successor will decide.
China will also lose money on its bonds because the interest rate on U.S. Treasury bonds will almost certainly rise as the economy recovers. The Congressional Budget Office projects that the yield on 10-year Treasury bonds will rise from 3.0 percent today to 4.8 percent in a few years. This would imply a loss of about 15 percent in the value of a 10-year Treasury bond.
For these reasons, Mr. Wen knows that China will lose money on its Treasury bond holdings. The news reporting on his comments should be asking why he is complaining about the risk of losses that he knows are virtually certain.
--Dean Baker
COMMENTS (10)
(Perhaps it has something to do with the US treating China like dirt, the US getting all huffy when China tells them to stop spying, the US getting all high and mighty whilst engaging in torture, the US throwing a fit when China wants to buy an oil company...)
Posted by: B.Dewhirst | March 14, 2009 1:54 AM
Dean, that was a thoughtful and well-reasoned post. High officials in the Chinese government and the bureaucracy should understand all of your points. I suspect however that Mr. Wen's comments are for domestic Chinese consumption. I also suspect that the US will be officially demonized in China as the perpetrators of the global crisis and the reason why Chinese are unemployed, etc. There will be little or no mention of currency pegs and the inevitability of loss in purchasing US debt in the official press there.
Posted by: Doc at the Radar Station | March 14, 2009 7:54 AM
If the Chinese hold their long-term bonds to maturity and if there is little inflation they won't lose if rates go back up (this was mentioned in the original article). Or they could actually sell now, realizing the gains they have made on Treasuries they bought when rates were higher, and put the money into something they have more confidence in - this could be in China if they don't like the Euro exchange rate. This would be called putting their money where their mouth is.
Anyway, I agree with Dean that the Chinese must know that their US investments will probably be losers in the long term, and that the media apparently don't know this.
Posted by: skeptonomist | March 14, 2009 9:43 AM
Here's another way to look at it:
China has been pursuing a deliberate policy of pegging the exchange rate to facilitate exports to the US. This policy has been extremely sucessful for China in the short term, and Chinese leaders must know the ultimate consequences of their US investments, as Dean says. This policy has also been beneficial to US capitalists who can take advantage of low Chinese labor rates, but it has been harmful to US labor.
The media, and indeed many economists, have been pushing the idea that Chinese investment will be needed to finance the US deficits. This is simply false - no foreign investment was needed to finance previous massive war-time and other debts. The extent of Chinese investment in the US is determined by the balance of payments, as Dean has tried to make clear.
So why are the media so concerned about what China wants? Could this be a reflection of the interests of those capitalists who want to use Chinese labor?
Posted by: skeptonomist | March 14, 2009 10:13 AM
I'm sure glad Dean commented on this story.
I have another worry about the story. I've noticed a worsening in Chinese-American relations for a couple of months now, including military.
I'm also worried that the NYT's story quoted the Peterson Institute. What's the idea at the NYT? Guarantee the debt to the Chinese with our Social Security?
I'm detecting a worsening of relations, and that is definitely not good.
Posted by: John | March 14, 2009 1:03 PM
I think sketonomist is on to something here in that GE (corporate parent to CNBC) among other has a huge investment in Chinese manufacturing in order to import into the U.S. that would be injured if the dollar fell against the Yuan/reminbi. At the same time, don't think the Chinese are being very clever. Like all humans, they are capable of cognitive dissoance and wanting to have their cake and eat it to. They want to keep the export model of growth based and they want to make money on their dollar investment. The fact that both can't happen (although in the last year the dollar has gone up against both Euro, Pound, CH, and Yen a great deal) long term does not mean they have to accept a fact that their interests causes them to pretend that it not exist.
Posted by: Rick Kane | March 14, 2009 9:00 PM
Doc got it right. Mr Wen made those comments primarily for the Chinese people. In China, the most powerful tool and most important consideration is the minds and sentiments of its people. For Mr Wen to have made such a public statement is pure showmanship and was in response to Clinton's recent visit and fodder for the Chinese public.
The Chinese actually don't give the first hoot about what the rest of the world thinks. The important thing in China is to gather and control the minds of the Chinese people themselves.
Posted by: willie | March 16, 2009 4:33 AM
From an economic point of view, the Chinese leaders must keep trade with the US going, and they have put priority on controlling the exchange rate. Since they are not elected, opinion in China is not so important, but anyway the Chinese people will be pleased as long as employment and their income is growing. So we should probably guess that Wen's remarks are in furtherance of the above two objectives.
Posted by: skeptonomist | March 16, 2009 10:11 AM
"...the Chinese leaders must keep trade with the US going"
At some point they'll captured enough of the world's industrial/engineering capacity that they'll be able to write their own ticket...until then the peg must continue along with demonetization of the US for domestic purposes [see aftermath of Tienanmen square]
Posted by: S Brennan | March 16, 2009 1:08 PM
Hyperinflation and the crash of the Keynesian model could be in the offing soon if the Chinese drastically draw down.
http://tinyurl.com/da295v
mB
Posted by: mjB | March 21, 2009 12:29 AM