China’s Premier concern about U.S. Treasuries not good news

Relying on the kindness of strangers is not a very good way to ensure one’s fate. However, this is certainly what the United States has been doing in running about a mountainous current account deficit. America’s largest creditor is now worried that the U.S. is not a good risk and has said so in public for what I believe is the first time.

Given the mounting U.S. government deficit, this cannot be good for the U.S. Treasury market. And indeed long-dated treasuries have already sold off (You should note that in December I saw Treasuries rising this year due to a very weak economy. Clearly, that is not happening).


Where is all this leading? Yves Smith has some good commentary on just this issue.

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.

The crux of the matter here is that the U.S. via the IMF basically forced the Asian economies to suffer considerably when it loaned them money back in the late 1990s during the Asian crisis. Many believe this was wrong-headed, including the former Australian Prime Minister Rudd, who has accused now-U.S. Treasury Secretary Tim Geithner of being blameworthy in this episode. As a result, the Asians have decided never to rely on the IMF or the kindness of strangers. This has developed into a policy of building massive U.S. dollar currency reserves as the U.S. dollar is the world’s reserve currency.

It is also responsible for the so-called excess savings that Asians have built in the past decade, which many Western bankers and politicians including Sir Alan Greenspan have deemed responsible for the credit bubble (see my take in “The Blame Asia Meme.”). Therefore, in a very real sense, one can see a boomeranging of policy errors from a decade ago having adverse effects today.

However, you look at it, this is a real problem.  The United States still needs foreign money to finance its deficit spending and economic stimulus.  However, to the degree that this economic policy leads to continued overspending by Americans, we are right back to the dynamic which created huge global imbalances in the first place.  And it does seem this is what the Obama Administration is advocating.  Witness Larry Summers’ comments in a recent interview with the Financial Times:

Barack Obama’s top economic adviser has urged world leaders to pump more public money into the economy in a co-ordinated effort to boost demand and lift the world out of recession.

In an interview with the Financial Times, Lawrence Summers said the urgent need for a short-term increase in spending by governments temporarily overrode the longer-term goal of tackling the global imbalances many economists believe caused the financial crisis.

The US administration had no choice but to take strong public action to “save the market system from its own excesses”, he said.

His comments, ahead of next month’s crunch G20 summit in London, make it clear that the US administration wants industrialised nations to share responsibility for engineering a global demand-led recovery and does not believe this burden should fall on China alone.

“The old global imbalances agenda was more demand in China, less demand in America. Nobody thinks that is the right agenda now,” said Mr Summers.

“There’s no place that should be reducing its contribution to global demand right now. It is really the universal demand agenda.”

While the US and other western nations should return to living within their means in the medium term, everyone should raise spending sharply now.

“The right macro-economic focus for the G20 is on global demand and the world needs more global demand,” said Mr Summers.

Is Summers asking American consumers to spend more or is he suggesting that the increased demand in the U.S. will come from government? Certainly boosting Chinese domestic demand is critical for the global economy. But, it is not clear to me that Summers’ ‘Universal Demand’ agenda is a departure from the global imbalances of the past decade. Moreover, it does seem clear that the U.S. is employing a diplomatic strategy on the economy that is meeting resistance abroad and risks torpedoing the upcoming G-20 meeting.

The China-Treasuries meme is a theme we should definitely watch going forward because it is important for the bond market, as a signal for U.S. foreign relations, and as a key pillar of the present global economic framework.

Obama’s economic saviour savaged as Keating lets rip – Sydney Morning Herald
Summers backs state action –
China’s Wen Worries About Safety of Treasuries, Asks for Reassurance – Naked Capitalism
Government Bonds, U.S. Treasuries –
‘Difficult’ Americans hamper G20 efforts to secure a global deal – Times Online

  1. Vangel says

    Once again the policy makers make the error of arguing that a fiat currency is equivalent to commodity money or capital. It isn’t.

    The end game looks to be a massive devaluation of the USD that will cause an adjustment in consumption patterns. Americans will see their standard of living decline as foreigners are better able to bid up the price of scarce resources and increase their own consumption even as Americans and Europeans cut back on theirs.

  2. aitrader says

    If the US does not have a backup plan for a sharp drop or cessation of Chinese support for Treasuries then it is really heading for troubled waters. After the recent military incident and increased tensions, the Chinese will naturally use their massive Treasury holdings and the need for their continued participation in Treasury auctions as leverage to further political goals. For the US not to prepare for this would be naive indeed.

    I would ask the question, “Who would the US look to to take up the slack if the Chinese step out?”. One answer might be a domestic “Buy America” drive as in WWII. Another would be friendly Middle East sovereign wealth funds such as Qatar, Saudi Arabia, UAE, and perhaps even Iraq. Would Russia be able to step up in return for concessions on Eastern Europe? And what of Japan, whose economy appears unable to support a continued high demand for Tresauries? Many questions ahead IMO…

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