Thursday, February 18, 2010
An article I wrote yesterday on Angry Bear blog:
No, the US Treasury's time is not running out. Where's Brad Setser when you need him - and the media definitely needed him in reference to the December TIC report.
Okay, okay, we know: China dropped its share of Treasury holdings in December by $US 34.2 bn. China now holds just 20.9% of the total foreign-owned stock of Treasuries, second only to Japan (21.3%).
But China’s share is closer to its average, while Japan’s share is way off – there may be a reversion here, i.e., Japan will grow its stock of Treasuries relative to China (Please see my post yesterday). Except for the period of September 2008 through November 2009, Japan held a much larger share of Treasuries than did China for every month since 2000.
Is there a sinister plot developing? Is China selling off S-T T bills to retaliate against the Obama administration’s push on the renminbi? Or is China simply reallocating its portfolio toward risk?
Perhaps there is a (partial) retaliation scheme underway, as suggested by the 3-month accumulation of short-term US assets (mostly T bills agencies with a maturity of less than 1 year).
But isn’t it just slightly more plausible that the Chinese are – official + private – selling off zero-yielding (practically) Treasuries in exchange for longer-duration, higher-yielding, and riskier assets.
The first bit of the story is this: one should take care in not reading too much into the TIC report. It’s just one month’s worth of data; but more importantly, the data miss a critical component of the capital account, foreign direct investment.
The chart above illustrates China's one-year rolling monthly flows of long-term, high quality asset purchases - Treasuries bonds/notes, agencies, stocks, and corporate bonds. The Chinese are accumulating stocks, primarily through private investors, but through official channels as well (see press release, lines 8 and 13). This suggests an increasing interest in equity, which could signal growing foreign direct investment flows (not shown in TIC).
Furthermore, the entire year’s shift in assets, long-term Treasury purchases, +$US 98.8 bn fully offsets the drop in short-term Treasuries, -$US 98.8. This suggests diversification.
Finally, everybody’s doing it, not just China - diversifying away from T bills, that is!
The chart above illustrates the 3-month rolling sum of all foreign net flows of ST US assets (mostly T bills). If you invest $US 1 million dollars today in a bill expiring in August 2010, you make about 900 bucks. Man, doesn’t that sound like a wonderful investment?
So the next question is: why do the Chinese care about return on their F/X holdings? Because they have a peg! Here is a great article for all of you who wanted to know about the costs of maintaining a peg. Accumulating FX reserves is a costly business, and T bills are unlikely to finance the type of sterilization that is needed by the PBoC.