Yesterday, Chinese Premier Wen Jiabao
aired his country’s growing concerns about continuing to lend money to
the US. Within the context of the US economic stimulus plan and other
related US spending initiatives, Mr. Wen is understandably anxious about
China’s vast holdings of US Treasury securities:
President Obama and his new government have adopted a series of
measures to deal with the financial crisis. We have expectations as to
the effects of these measures. We have lent a huge amount of money to
the U.S. Of course we are concerned about the safety of our assets. To
be honest, I am definitely a little worried.
While the announcement represented political posturing (to an
increasingly restless, domestic Chinese audience), it should nonetheless
be heeded as a warning, that the US cannot expect China (and other
foreign Central Banks) to fund US budget deficits indefinitely.
Let’s put aside the rhetoric for a moment, and examine the data. This week witnessed strong demand
for Treasury securities, which were auctioned by the Treasury
Department on consecutive days. Despite historically low yields (see
chart), investors continue to snap up Treasury Bonds, mainly for the
sake of risk aversion. The newly-revived issuance of 30-year bonds also
went off without a hitch, and were more than 2x oversubscribed. Most
relevant to this discussion is the fact the foreign Central Banks
accounted for as much as 46% of demand!
The most recent Federal Reserve Statistical Release
paints a similar picture. While foreign Central Banks and other
international institutions reduced their holdings of US government
securities slightly from the previous week, the decrease was essentially
negligible. Overall, such entities have increased their holdings by at
least $440 Billion over the previous year, bringing the total to approximately $3 Trillion
(depending on the data source). China’s contribution remains
substantial. Of its $2 Trillion in foreign exchange reserves,
“Economists say half of that money has been invested in United States
Treasury notes and other government-backed debt.”
However, there are a few reasons why I don’t think this trend will
continue. First of all, the buildup in foreign Treasury holdings that
transpired over the last decade was largely a product of unsustainable
global economic imbalances, as net exporters to the US invested their
perennial trade surpluses in what they perceived to be the world’s most
secure investment. Temporarily putting aside whether Treasuries are
actually secure, economic indicators suggest that Central Banks simply
do not have the capacity to increase their holdings by much more. China’s trade surplus plummeted to $4.8 Billion last month; one economist projects a surplus of only $155 Billion in 2009, compared to nearly $300 Billion in 2008.
You can also remove from the list Japan- the second-largest holder of US Treasury securities- which is now running a trade deficit.
Instead, both countries have publicly announced plans to use some of
their forex reserves to fund domestic economic initiatives.
Then there is the equally unsustainable short-term buildup in US
Treasuries, which is largely a product of technical factors. As I
mentioned above- and which should be clear to all investors- the current
theme underlying securities markets is one of risk aversion. In fact,
it now appears that a bubble is forming in the bond market,
and “any exodus now could spark selling across the board. Foreign debt
holders would likely repatriate their funds immediately to reduce the
risk of being last to convert.” As soon as markets recover- of which
there are already nascent indications- investors will probably reduce their holdings of government bonds, or at least not increase their holdings.
Even the most conservative projections indicate a cumulative budget
deficit for the next few years measuring in the the Trillions. Unless
the risk-aversion theme obtains for the next decade, it seems unlikely
that foreigners can be tapped to fund more than a small portion, leaving
the Federal Reserve (with the help of its printing press) to make up the shortfall.
Central Banks Maintain Holdings of US Treasury Securities, but For How Long?
Friday, March 13, 2009
Labels:
Central Banks
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