America no longer needs Chinese money, for now
by Ambrose Evans-Pritchard
Originally published 22 Aug 2010
As the Sino-American showdown in the South China and Yellow Seas escalates into the gravest superpower clash since the Cold War, the United States cannot wisely rely on China to help fund its budget deficit for any longer.
THE CACOPHONY OF VOICES IN BEIJING QUESTIONING OR MOCKING the credit-worthiness of the US is now deafening, from premier Wen Jiabao on down. The results are in any case manifest: US Treasury data show that China has cut its holdings of Treasury debt by roughly $100bn (£65bn) over the past year to $844bn.
ZeroHedge reports that net purchases by the big three of China, Japan, and the UK (Mid-East petro-dollars) have been sliding for two years. In August they bought the least amount of US debt this year. China is finding other ways to recycle its trade surplus and hold down its currency, buying record amounts of Japanese, Korean, Thai, and no doubt Latin American bonds. “Diversification should be the basic principle,” said Yu Yongding, an ex-adviser to the Chinese central bank.
Beijing is buying gold on the dips, or doing so quietly through purchases of scrap ores, or by deals with miners such as Coeur d’Alene in Alaska. It is building strategic reserves of oil and coal, and probably industrial metals. State entities are buying up natural gas reserves in Africa and Central Asia, or oil sands in Canada, or timber in Guyana. Where this expansion runs into political barriers, they are funding projects – such as a $10bn loan to Petrobras for the deepwater oil off Brazil. Where all else fails, they are buying equities. All of this recyles China’s reserve surplus away from US debt.
Or perhaps JP Morgan has an extraordinary prejudice against bonds, arguably the shrewdest asset in a world where fiscal stimulus is being withdrawn before the rest of the economy has reached “escape velocity”. The inventory cycle is ebbing, manufacturing has tipped over, the workforce is still shrinking, and the economy is sliding into a deflationary rut. Above all, bond appetite reflects what David Rosenberg at Gluskin Sheff calls the new frugality. Americans are saving again. Surplus nations are in for a nasty shock if they hope to feed off US demand as if nothing had changed.
Yet bond yields have fallen to nose-bleed levels. Ten-year rates are at an all-time low of 2.27 in Germany, and back to 0.92pc in Japan’s deflation laboratory. They have slid to 2.6pc in the US. When yields plumbed these depths over the winter of 2008-2009, latecomers burned their fingers badly. 10-year Treasury yields doubled in five months as the effects of zero Fed rates, quantitative easing, and $2 trillion of fiscal stimulus worldwide halted the downward spiral.
This time yields may stay low for longer. Fiscal and interest rate ammo has been exhausted, though not QE. I have little doubt that central banks can lift the West out of debt-deflation if needed with genuine QE – not Ben Bernanke’s Black Box “creditism”, or Japan’s fringe dabbling. Whether they have the nerve or the ideological willingness to do so is another matter.
Does that mean bond yields must keep falling to unimaginable lows, as they have in Japan for twenty years? Perhaps, but Japan is sui generis (captive bond market, vast foreign assets, demographic atrophy), and the world has moved on. As Moody’s said this week, the Great Recession has made sovereign debt suspect. “The burden of proof now falls on governments”. Events have “fast-forwarded history”, ripping away the 20-year cushion we counted on before the “adverse debt dynamics” of our aging crisis hits home.
Two epochal forces are colliding in the global bond market: core deflation is gathering force but the West is losing sovereign credibility just as fast.
Arch-bear Albert Edwards at Société Générale advises clients to prepare for a violent policy swing from one extreme to the other. First we deflate into the abyss: then we inflate hard rates to get out again. At some point the “euthanasia of the rentier” will wear off. Misjudge the sequence at your peril.