Nervous Times In China

The Chinese are learning the hard way about an old American banking story. The man who owes the bank $50,000 dollars on a secured loan may lay awake at night worrying about how he can repay the loan. If the same man owes the bank $5,000,000 of unsecured debt, it is probably the banker who is awake all night wondering if he is going to get paid.

Chinese Premier Wen sounds like he is having some sleepless nights worrying about whether or not the US will be able to repay the $700 billion that China invested in US treasury securities. In a remarkable statement, Premier Wen publicly stated that he is “worried” about the ability of the US to pay back its huge debts to China. As reported in Bloomberg, Wen is asking for assurances from the US that the debt is safe.

“We have lent a huge amount of money to the United States,” Wen said at a press briefing in Beijing today after the annual meeting of the legislature. “Of course we are concerned about the safety of our assets. To be honest, I am a little bit worried. I request the U.S. to maintain its good credit, to honor its promises and to guarantee the safety of China’s assets.”

U.S. Secretary of State Hillary Clinton urged China, while visiting officials in Beijing on Feb. 22, to continue buying U.S. debt, which she called a “safe investment.”

“China is worried that the U.S. may solve its problems with the fiscal deficit and banks by printing money, which will stoke inflation,” said Zhao Qingming, a Beijing-based analyst at China Construction Bank Corp., the country’s second-biggest lender. “If the U.S. can make sure this won’t happen, then China will continue to invest.”

Delegates of China’s legislative advisory body suggested that the biggest foreign holder of U.S. debt diversify away from Treasuries into more risky assets at the annual meeting that started on March 3.

Jesse Wang, executive vice president of China Investment Corp., said on March 4 that his $200 billion sovereign wealth fund may invest in “undervalued” commodity assets. Zhang Guobao, head of the National Energy Administration, said China should invest more in commodities instead of hoarding the U.S. dollar, the official Xinhua News Agency reported on March 7.
China should seek to “fend off risks” as it diversifies its $1.95 trillion in foreign-exchange reserves and will safeguard its own interests, Wen said. Chinese investors held $696 billion of U.S. Treasuries as of Dec. 31, an increase of 46 percent from the prior year.

Chinese Concerns Justified

China is justified in worrying about its large US treasury investment, despite the worthless assurances from our Secretary of State. Congress is blithely spending money by the trillions, as Chairman Bernanke continues to speak of buying mortgage backed securities and long term treasuries. One of the major constraints on Chairman Bernanke’s desire to print money (via the purchase of US government debt) has, no doubt, been the worry about a potential backlash from China, the biggest buyer of US debt.

The heretofore mutually beneficial arrangement of China purchasing US debt with trade surpluses generated by American purchases of Chinese goods is drawing to a close. China’s trade surplus has all but evaporated, eliminating the need or ability of China to purchase additional US debt. In addition, the Chinese have made it clear that their national interests are best served by diversifying into commodities and other real assets, the value of which is not contingent upon an overleveraged debtor nation.
End Game Clear

As long as China continues to purchase US debt, Bernanke is constrained from blatantly printing money. As China throttles way back on its purchase of US debt, America will have three choices – 1. Borrow and spend less 2. Raise taxes tremendously or 3. Print money. Based on what we have seen so far, it will be some of number 2 and a lot of number 3.

The odds are that China will ultimately get its money back, but the value of what they receive will be far less than what they gave.