Michael Shedlock

One of the big questions now being debated is, "What would happen if China were to dump its entire Treasury portfolio in one fell swoop?" Caroline Baum addressed that question in “China Doesn’t Steer the U.S. Interest-Rate Ship” :

“Like a highly contagious virus, fear that foreigners will dump all their U.S. Treasury securities spreads through the market at periodic intervals.

“The fear is not totally unfounded. Foreigners own a little more than half of publicly held U.S. government securities, according to the Treasury Department. So if these foreigners — both central banks and private investors — woke up on the wrong side of the bed one morning and decided to give the Treasury portfolio the old heave-ho … well, you can begin to understand the basis for the recurrent nightmare.

“‘When people say, What happens when foreigners dump U.S. securities, I say, Tell me why,’ says Jim Bianco, president of Bianco Research in Chicago. ‘It’s never happened before’ on a long-term basis…

“The latest bout of flu-like symptoms was triggered by news earlier this year that the People’s Bank of China was setting up an investment vehicle to diversify its $1.2 trillion of dollars…

“Real-World Example

“Last month, China announced it was investing $3 billion of its dollar reserves in Blackstone Group LP, manager of the second-largest buyout fund, to boost its returns. What if China were to shoot itself in the foot and dump its entire Treasury portfolio in one fell swoop?

“It just so happens we have a real-world example of what it would mean, according to Bianco. The Bank of Japan bought $244 billion of Treasuries in the 12 months ended August 2004. During that time, U.S. long-term interest rates rose and the dollar fell versus the yen.

“By April 2006, the BOJ was a net seller of U.S. Treasuries (on a 12-month basis) to the tune of $26 billion, a swing of $270 billion. U.S. interest rates fell during that period while the dollar rose.

“‘The BOJ bought a quarter-trillion dollars of Treasuries and then abruptly stopped and no one noticed,’ Bianco says.

“Never let the evidence stand in the way of a popular obsession.”

While I agree with Bianco that no one noticed when Japan stopped buying, that is not a valid model for what would happen if China (or Japan) were to dump its entire Treasury portfolio in one fell swoop. There is a big difference between stopping additional purchases (or selling them slowly over a period of time) and a massive dumping of everything at once.

Furthermore, given that Bianco states, "It’s never happened before," how can he (or anyone else) come up with a "real-world example"? Isn’t that an enormous contradiction? Nonetheless, I am sympathetic toward what I believe to be a key idea of the article: that China or Japan stopping additional purchases or divesting slowly over time does not necessarily spell disaster. There IS a real-world example of that, with falling Treasury yields to boot. On that score, it’s as Caroline suggests: "Never let the evidence stand in the way of a popular obsession."

Are Dumping Fears Overblown?

Greenspan says there is nothing to fear: “Former Federal Reserve chairman dismisses fear of China dumping U.S. Treasuries”:

“There is little reason to fear a wholesale pullout by China from U.S. government bonds, former Federal Reserve Chairman Alan Greenspan said Tuesday.

“While expressing concerns about China’s runaway growth rate and what he described as overvalued stocks, Greenspan played down the prospect that Chinese authorities would sell Treasuries in earnest, forcing a sharp spike in U.S. interest rates.

“Asked at a commercial real estate conference if investors should be worried about this oft-cited concern, Greenspan said: ‘I wouldn’t be, no.’

“Still, Greenspan said the reason such a withdrawal was unlikely was that China would not have anyone to sell the securities to…

“Greenspan said that a global liquidity boom, which he traced back to the end of the Cold War, would not go on forever.

“‘Enjoy it while it lasts,’ he told the audience.

“Now a private-sector consultant, following more than 18 years at the U.S. central bank, Greenspan reiterated his prediction that China’s latest growth spurt had come too far, too fast.

“‘We cannot continue this rate of growth in China and the Third World. This cannot continue indefinitely,’ Greenspan said in a speech. ‘Some of these price-earnings ratios are discounting nirvana.’”

Now, there’s a comfort… China won’t sell them because "China would not have anyone to sell the securities to." So instead of accumulating more Treasuries, China is plowing U.S. dollars into inflated U.S. stocks, agencies (tied to horrendous fundamentals in the U.S. housing market), junk bonds, and other garbage.

Why is it that foreigners always buy market tops (first Treasuries, now equities)? Regardless of the answer to that last question, there’s always a buyer at the right price. That holds true for housing, Treasuries, and even CDOs.

Let’s have a count of hands, please: Other than bond funds that deal in Treasuries, is there anyone anywhere that has anything positive to say about Treasuries? Has such pessimism at market bottoms ever in history been rewarded?

There’s no denying that China has cut back on Treasury purchases. In fact, avoidance of U.S. Treasuries in now approaching a near mania everywhere, even as funding can easily be found for the junkiest of junk offerings (not related to housing). But is there any reason for China to do a wholesale dump? I personally doubt it.

More to the point, is lack of foreign demand the reason for the recent bond sell-off? That’s what everyone seems to believe, but if that were the reason, then what was the explanation for falling yields as Japan was selling?

Greenspan has been wrong at every major turning point his entire career. The fact that Greenspan states there would be no buyers could be yet another of a long series of contrary indications suggesting that internal demand just might be ready to soar. If that’s the case, the real question, then, is: "How high do yields get in the meantime?" as opposed to these unlikely "what if?" scenarios. As an aside, the higher rates get in the meantime, the bigger the debacle in housing. It’s a no-win situation for the Fed.

Regards,
Mike Shedlock ~ “Mish”
June 18, 2007

Michael Shedlock

Mike Shedlock (Mish) is a registered investment advisor representative for SitkaPacific Capital Management. His blog Mish's Global Economic Trend Analysis includes commentary every day of the week. Mike is also a contributing "professor" on Minyanville. SPECIAL REPORT- The Endless PAYCHECK PORTFOLIO: In three simple steps, unleash a steady flow of work-free income... starting with up to 75 automatic "paychecks" deposited directly into your account.

  • http://economistatlarge.com Andrew Matuszak

    As a follow-up, the Treasury department released the December 2009 international capital report yesterday (2/16/10). As expected, its stirred up lots of scary talk about China dumping US assets. The reality of the situation is that they have very little in the way of alternatives. They run a large surplus and have committed to pegging the Yuan to the dollar. So in the short term, it would be very difficult for them to dump any large amounts of US assets. (They can switch between short and long term or between short term debt and equity–both which they’ve recently done.)

    I’ve written a more detailed explanation at http://economistatlarge.com/featured-articles/risk-chinese-selloff.

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