Look, I love the Financial Times, but even the pink paper has its off moments.
Today, the FT reports, with the journalistic equivalent statement of a straight face, a patently ridiculous statement from China’s State Administration of Foreign Exchange:
China has delivered a qualified vote of confidence in the dollar and US financial markets, ruling out the “nuclear option” of dumping its huge holdings of US government debt accumulated over the last decade.
But the State Administration of Foreign Exchange, which administers China’s $2450bn in reserves, the largest in the world, also called on Washington and other governments to pursue “responsible” economic policies.
The statement on Wednesday, one of a series that Safe has issued in recent days in an apparent effort to address criticism about its lack of transparency, also played down the chances of China making major further investments in gold.
Yves here. Earth to base, China did not buy dollar assets as in investment. Its purchases were made as part of a mercantilitst strategy to keep the renminbi cheap and thus assist exporters. The wee problem is that its huge dollar assets have become a contentious issue domestically, with many Chinese resenting the fact that China’s holdings of dollar assets are likely to depreciate. Well, that was inevitable. Emerging markets currencies typically appreciate as the country develops. So any large scale investment in foreign assets in an advanced economy was likely to be a bad bet. And it was CERTAIN to be a bad bet if those assets were acquired with the deliberate intent of keeping your currency low relative to the currency being acquired. As Dean Baker pointed out, apropos a 2008 New York Times story:
It was understandable that China’s central bank might buy up dollars in a conscious effort to keep the dollar high and thereby sustain its export market to the United States. This would mean that China was effectively paying people in the United States to buy its exports. This would be a reasonable growth strategy if China for some reason lacked the capability to generate this demand internally….
However, it would be bizarre if China’s central bank bought up dollar denominated assets in the last 7-8 years thinking that they were making a good investment…..Apart from buying bonds from Zimbabwe, it’s hard to imagine how they could have made a worse investment.
If the people who run China’s central bank are really this ignorant, that should have been the headline of the article, which should have been on the front page.
Put it another way, the idea that China would “punish” the US by selling dollar assets is as credible as Cleavon Little’s pretending in Blazing Saddles that his threat to shoot himself is, well, a threat:
Except in life as in fiction, some people actually seem to buy it.
If China dumps dollar assets, its currency would soar in value. That’s the last thing it wants. So the only conclusion possible is that the Chinese are as dumb as the Blazing Saddles townspeople, or they need to make impressive sounding empty pronouncements to appease a domestic audience.
Once it gets past the silly headline (“China rules out ‘nuclear option’ on T-bills”) and recitation of SAFE’s blustering, the FT article does provide some useful intelligence on the question of when and how China might move away from a currency policy fixated on the dollar to one that looks at a broader range of currencies (it announced such a shift in 2005, took a small step towards implementation in 2007, returned to a dollar peg in 2008, and announced it would adopt a more market oriented posture and again manage the RMB against a basket of foreign currencies, but there has been nary a clue as to when that might actually start to be implemented). The details:
Safe’s comments coincided with the news that China had made record purchases of Japanese government bonds in the first four months of the year, helping push the yen to an eight-month high against the dollar.
Analysts said it was too early to tell whether China’s move into JGBs was the start of a trend, but Greg Gibbs, FX strategist at RBS, said unlike in the US, Tokyo would not welcome foreign central banks routinely accumulating yen assets.
Yves here. This is a nasty bit of business. Keeping the yen at elevated levels is damaging to Japan. The US tolerated the yen at a lower level than it arguably should have been in the 1990s precisely because a strong yen would have been devastating to its fragile economy. The FT again:
“If this persists it may generate tensions between Japan and China. It would seem a little ridiculous for Japan to allow the yen to be pressed upwards by inflows from China, when Japan is not able to counter with renminbi asset purchases,” said Mr Gibbs.
And if you think the dollar is a bad investment longer term, that’s at least as true of the yen. It’s significantly overvalued and has terrible demographic headwinds on top of its persistent deflationary pressures.
Excellent article. My take exactly, except the FT was just reporting what SAFE said. The questions are, why did they say it (ie who is the real intended audience), and why did they say it now?
My view is that the SAFE statement was in fact very important, and the audience was Western Central Banks, and the message was”no more qe/stimulus”.
Great clip from Blazing Saddles, Yves.
Made my day!
Love the ‘Blazing Saddles’ clip. I’ve long thought that that scene is the best description there is of the Chinese Nuclear Option (which AFAIK even China hasn’t threatened to use, but lurks in the imagination of those who fear any trade confrontation).
For the impatient, the relevant part starts at 2:40 in the video.
Even the low yield (nuclear wise) version of the Nuclear Option, selling some of their treasuries or at least not buying them, is an odd idea of a threat. Do what we want or we swear we’ll do what you want! Selling some of them would reduce the exchange value of the dollar, reduce our trade deficit, and help the US economy.
The only down side I can see is that it might require the yield on treasuries to go up. It’d probably be worth it though.
Bah! This is easy to solve.
China’s central bank just needs to issue credit cards to all the chinese citizens (oops, consumers) with 1-year no payment/low interest teasers and send them off on a buying spree to eat up all the production.
Then, they can easily ditch the dollar.
THEN in a few years they can sell junk securities to India. to roll over their central bank debt.
THEN India can have it’s turn.
HOW COULD IT FAIL?!?!?
(ugh, too much coffee…)
Follow the oil…. current coupon on Chinese owned US treasuries buys ~30% of their imported oil. Same as Japan. The Chinese will hold dollars as long as oil is priced in dollars. So yes, it is exactly like Blazing Saddles
How is oil a reason to hold treasuries? (other than some rainy day fund that’s a lot smaller than $2.45T). China constantly receives dollars as we buy stuff from them – no need to rely on coupon payments when you’ve got a steady cash stream.
In the longer run view having the US dollar as the world’s reserve currency has become a golden noose. The advantages are more than outweighed by the disadvantages. Personally I’ve always like Keynes’ Bancor proposal.
How is oil a reason to hold treasuries?
Because the same people who control the Department of the Treasury and the Federal Reserve System control the US Navy (& US Air Force). If they were adequately provoked they could refuse to allow oil tankers to sail to Chinese ports.
So what leverage does holding treasuries give China? The nuclear option would hurt them more than us, and the low-yield option would just plain help us.
China holds $2.45T, largely in US treasuries, to keep the yuan undervalued. No other explanation is needed.
Oil contracts are usually denominated & settled in US dollars – that might be what he’s referring to.
I can see how settling dollar contracts with dollar income would mitigate currency risk for a country with a floating currency, but I’m not sure how much value it would have for China. Reducing exchange flows?
I read the article and thought it preposterous. I expect SAFE will sell dollars. Quietly. I remember 1967’s British Pound devaluation. The Chancellor of the Exchequer lied for months, saying he would not devalue the pound. Then, he did. He said something to the effect that he couldn’t disclose his plans, lest he enable the speculators to profit.
“I expect SAFE will sell dollars. Quietly.”
To me that’s reason to be hopeful, but I hate to latch onto anything without a good reason. I’m sure they’d like to do it quietly if they do it, but that doesn’t mean they will do it.
I agree with the comment that China’s large foreign reserves are a result of its trade policies and not any investment plan. Selling it’s dollar reserves and converting the proceeds to yuan would be devastating for it’s exporters.
However, it is not as clear to me why it couldn’t sell treasuries and buy pounds, euro, and yen denominated assets in some combination. That would have the potential to create huge havoc in the underlying markets and demonstrate China’s power w/o the direct impact on its trade. I’m not claiming it will do this, but it seems like a credible risk.
It’s important to understand how China buys and sells T-securities. China first must obtain dollars and deposit them in a checking account at the Fed.
When it buys T-securities (erroneously called “lending us money”), those dollars simply are debited from China’s checking account at the Fed and credited to its savings account at the Fed. All owners of T-securities, even you and me, have a de facto savings account at the Fed.
Then, when China wishes to sell its T-securities, the dollars are debited back from its savings account and credited to its checking account. Why this simple transfer is considered a “nuclear option,” I cannot imagine. No dollars are created or destroyed. They merely are transferred from one account to another, in the same bank. See: myth #4)
The only thing that destroys dollars is payment to the U.S. government. Taxes are one example. Another example: If China were to buy something from the U.S. government, those dollars of payment would be destroyed.
It would be well for those who worry about China’s T-security holdings to understand the fundamentals of this process.
Rodger Malcolm Mitchell
David, you said, “Selling it’s dollar reserves and converting the proceeds to yuan.”
Please describe the mechanics of how a monetarily sovereign nation can sell dollars and convert the proceeds to its own currency.
Rodger Malcolm Mitchell
The process I was referring to was selling its US Treasuries for dollars, then using those dollars to buy yuan in the market (or alternatively pounds, euros, or yen).
David, why would China want or need to buy yuan? It is the monopoly producer of yuan. What does a monopoly producer of a currency do when it receives more of the currency of which it already can produce an unlimited supply?
Rodger Malcolm Mitchell
A standard (theoretical?) equilibrium cycle for an exporting country is for the goods to be sold for foreign currency. In order to repatriate the earnings, the producers buy their local currency with their foreign currency earnings. This leads to an increase in the value of the local currency, an increase in the price of their goods, fewer sales, and eventually equilibrium.
China has interrupted this process by holding a large portion of the dollars they have earned. The implication in the article under discussion was that China could decide to dump these dollar holdings. Yves disagreed with this possibility based on the damage that it would do to their export based economy (by implication because of the impact on exchange rates if they purchased that much yuan). I agreed with her that they wouldn’t convert the holdings into yuan, but brought up the possibility that they could still divest from the dollar into other major currencies as a foreign policy weapon, though I didn’t suggest this was likely either – just that her objection didn’t seem to apply.
David, I agree.
There is a related question: Why does a nation wish to export? While an individual business benefits from exports, and even a non-monetarily sovereign nation benefits from exports, there is a question as to whether China (or other monetarily sovereign nations as U.S., Canada, Australia, Japan et al) benefit from exports.
I’ve posted a short discussion of this counter-intuitive concept at CHINA MYTH
Rodger Malcolm Mitchell
China could buy 24 million wives for their 20 million+ estimated bachelors at $100K dowries. That’ll pay off the debts of baby boomer parents.
They’d be insane to go on buying forever. When time comes to sell, they have two options (1) sell at a steady pace, (2) sell in surges. Selling in surges offers them many political opportunities. Isn’t this how we convinced the British to leave Suez? Also, in times of oil crisis, where there is not enough oil, they’ll have plenty of dollars so will get first grabs.
There may be another reason why china
likes US dollars. China monetray authorities lack credibility in the world markets… Hence, in the past, if they were to print yuan, even for
internal use, it would be viewed as inflationary, and it’s currency would depreciated on other foreign exchanges… Possibly causing other instabilites. However by printing it’s currency against a credible currency and maintaining that peg, china currency becomes credible, and of course what is printed is then injected into china’s economy via the foreign investor. With a large stable amount of us dollars, and with the prospects of a strenghtening economy, china may one day gain enough credibiltiy
to buy foreign goods in it’s currency, and have it’s debts denominated in it’s currency. Also, having a stable currency with a fixed peg rate and strong Capitol controls also discourages foreign currency speculation.
The Chinese and Russian gangs are getting better seats at the wealthy ruling elite IMF table. The Chinese don’t care about their domestic populations. The Chinese people, like those in scamerica, will be to busy fighting each other when their debt trap bubbles start snapping like fingers at a Mexican hat dance. Same movie different theater.
Debt trapping deflation by design — with ever more bogus currency derivative creation WITHOUT DEMOCRATIC ACCOUNTABILITY — will continue globally. Say hello to the two tier ruler and ruled world …
“The IRA: That would be us. The conventional view has always been that the other nations of the world, seeing their currencies rise in value as the U.S. defaults on its debt via inflation, would eventually inflate their own money to maintain some type of parity for trade purposes. What happens when the U.S. embraces quantitative easing as part of normal policy and begins to explicitly monetize the federal deficit?
Rickards: Well we are not there yet. Where the Treasury would like to lead us to is the SDR. Two important things happened in 2009. For the first time in history, the IMF leveraged its balance sheet. In the past, the IMF quota system was essentially equity. The IMF has obtained binding commitments to borrow over $500 billion worth of debt denominated in SDRs. The greater use of and acceptance of the SDR is step one and solves Triffin’s dilemma. Then step two, as China rises, we can dial up the value of the SDR by including the yuan. Remember that the SDR is rebalanced every five years and the yuan is not currently reflected.
The IRA: So if you add the Chinese yuan to the SDR, you devalue the dollar?
Rickards: Yes. The dollar buys fewer SDRs. This not only solves Triffin’s dilemma but also addresses beggar thy neighbor. We are not going to walk around with SDRs in our pockets, but this is how we balance global capital accounts and rebalance deficit and surplus countries in the trading system. You create a new asset against which you can devalue. But you also create a new asset which you can print without accountability to any democratic process. Nobody elects the G20 or the IMF.
The IRA: It turns the IMF into a global clearing house and central bank. In the post WWII period, the global ledger was dollars and gold on one side as reserve assets and the other currencies on the other. Now we are putting the dollar with everyone else. Does this arrangement result in fiscal discipline in Washington?
Rickards: No, I think it just kicks the game upstairs and down the road. China was a big buyer of these SDR bonds. They diversified with minimal market impact. The IMF took in dollars for their SDR notes and lent the dollars to Hungary, Iceland, etc. Thus the IMF not only levered their balance sheet, but they also created over a hundred billion in new SDRs. The IMF essentially printed money and they spread them all over the world to all of the member nations. I see this as testing the plumbing. Now the IMF is on standby. The next time we are in the situation that existed in 2008, you won’t see another $1 trillion stimulus package because we cannot afford it. Instead you’ll see a trillion SDRs going out the door suddenly. Remember, when they were first created in the 1970s SDRs were called “paper gold.”
More here …
Deception is the strongest political force on the planet.
If the U.S. Government joins private individuals and corporations in saving, then its purchase of imported (as well as domestically produced goods must contract). I am not sure how much a contraction of the U.S. economy will be necessary, but it would certainly mean buying a lot less “made in China” stuff then we do at present. This I think the Chinese don’t want. Nor will the resulting depression due much for the value of U.S. bonds China currently holds as they will be an investment in a depreciating currency (relative other fiat currencies)and a declining economy. I expect this plays well domestically as it creates a posture where the Chinese are telling us what to do and we obeidiently respond. It is no really obedience, it is simply are elite jumping at the opportunity to preseve their income and property from progressive taxation and rip up the welfare state.
With the world economy so dicey and likely headed back into recession, the dollar remains the best game in town, and the Chinese would have to be crazy to engage in large scale moves away from it.
The US has been tolerating a depreciated Yen, which began the cheap import addiction and the destruction of US industrial infrastructure, because we use them as military base. Instead of exports, we use military intimation in Asia to make our presence a force to be reckoned with.
The Chinese learned from the Japanese that by trading their Chinese business’s export profits (US dollars) back into US T-bills/gov. agency paper that it devalued their currency and created currency reserves that protected them from predatory speculation, and promoted the necessary dynamics of an export economy (cheap currency).
The game has matured to the point where capital, real wealth, which is the means of production has migrated to China.
The US has become the debtor and China the creditor. China is the bank, and creditors call the shots even to those perceived too-big-to-foreclose on. China is converting dollars into SDR/gold/commodities to ensure that they are not just holding the dollar bag.
China will use the nuclear option when they feel the time is right to withdraw support of the dollar. The US on the other hand, aware of this national security risk holds it’s own nuclear option. Sad to say, it’s only option. Correct me if I’m wrong.
It is the nuclear option, it’s just that they drop the bomb on themselves. Hopefully they’ve got Dr. Strangelove stashed underground somewhere, devising a survival plan!
“Gentlemen. You can’t fight in here. This is the War Room!”