We are removing the republican party from power at the federal level, half way there at the moment.

Until then the US federal government has one goal: postpone recession until after November 2008. There is little havoc they will not wreak to achieve it.

I am afraid you still have not addressed my main point. I am not arguing that central banks are not concentrated in treasuries. However, if spread product narrows when yields are falling, it is getting richer AHEAD of treasuries, which makes it difficult to argue that the driver for narrow spreads emanates from treasuries.

I am sceptical of the argument that central banks are missing a lot by under-investing in spread product. I suspect that this argument originates with the investment bankers who make more money from selling spread product and the agent fund managers, who find that the most reliable way to beat a bond index benchmark is to overweight spread product – if only their central bank clients will let them. Maybe some of those central banks who have invested in, say, ABS are regretting it now.

This is a truly interesting point, crucial I would say.. Some sort of adjustment has to take place as China grows larger in the world economy, but i have not read so far a serious analysis on this. Anybody has an opinion here? Brad maybe?

I do agree with you that the current way of growth for China needs adjustment. The surplus issue, the resource issue and the environment issue all require adjustment. However, to make things a little simpler, “reserve loss” should not be an issue for major concern.

As for the adjustment for the economic growth, it is one of the few big topics in the recent 17th party congress. The top leadership knows very well things have to be changed. However, adjustment needs time. Again, if money can buy time, the money (reserve loss) is well spent in my view. One the other side of the Pacific, the US also needs to adjust its behaviour. That change will also need time. But for years, I haven’t seen any meaningful policy (energy, environmental, labor, tax, etc) change from either the congress or the administration. Only the Fed is pumping out cheap credit to prolong the good time…

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To EthanJ, about “locked yourself into a policy of buying dollar assets” and “holding the bag”

First, I don’t think it is the case. With dollar, a person doesn’t have to buy dollar asset. He can by Australian assets and let some one else to use the dollar to buy dollar assets.

Second and but more importantly, the Chinese has an open scheme and knows the reserve loss may not to be avoidable. Speculators like Jim Rogers also has an open plan to take advantage of it. However, there is the capital control. And other countries may think the “unconditional finance” is a deal too good for the Chinese, then the game has to stop in the next few years. But back to the initial topic, whether the loss turns out to be insignificant or acceptable, the Chinese leadership should not take it as big issue. There are many other important tasks on the list.

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To AC, thank you for you comment too.

Sometimes, I think the Chinese long term thinking tendency is exaggerated. The central government may think about 10 years down the road. But the lower you go in the level of government , the shorter horizon you will find. For a normal city mayor, 3 years might be the window he can perform. Those “plans” for the next 20 or even 50 years are mostly hope or expectation of the people. Without enough power/resources, a person can hardly predict what will happen in 1 year. On the other hand, those on the top do have some kind of control for the near future. And they should think a little long term.

Lack of diversification doesn’t necessarily mean you have too much risk. The improper diversification I’m talking about is that foreign surpluses are overly concentrated in treasuries and agencies. That’s a fact – not an ‘if’ – just read this blog. They’re way too risk averse in terms of any normal benchmark on prudent asset diversification. No other money manager would be allowed to put so much money into one category, even if it’s the lowest risk category. That does the deed in terms of low treasury yields. This then causes the rest of the market to be short low risk assets so they reach for the next best thing, whatever that is, driving risk spreads lower due to excess demand for the next risk category.

You are right. The if is a very big if.

Unchanged risk spreads would mean that spread product HAS become more expensive in line with treasuries. If a large category of treasury buyers is not “properly” (whatever that means) diversifying, then treasury yields ought to fall more, no?

The very high concentration of foreign investors in risk free securities is consistent with a narrowing of risk spreads. This concentration pushes down treasury yields due to the size of the demand from a single source. And it pushes down risk spreads due to the lack of available risk free product, and the resulting demand by those who can’t get their fill to replace it with something else as close as possible to risk free. This all happens, not because of the size of foreign buying per se, but because a very large category of treasury buyers is not properly diversifying, causing resulting distortions in treasury pricing and risk pricing.

Sorry to repeat this, but this sort of arguments does not make much sense.. line segments do not exist in real life. Not to mention economics. Chinese growth will probably saturate when the country will reach middle income status. The yuan lost 5% versus the euro in 2006 and 2007: what happens if you extrapolate that for 13 years?

I agree though that what the chinese are doing makes a lot of sense in a medium-term perspective.