Brad Setser

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China has lost its appetite for risky assets

by Brad Setser
December 30, 2008

George Chen of Reuters reports that both the CIC and SAFE are scaling back their investment in risky assets. Word has come down from on high.

China’s foreign exchange watchdog, the State Administration of Foreign Exchange, will cut back on overseas equity buys next year after suffering major losses on the collapse of U.S. lender Washington Mutual, according to sources. ..

The big losses by SAFE in the WaMu deal through its investment in the TPG fund have drawn attention from top government leaders in Beijing, who have urged both CIC and SAFE to be more cautious on its overseas investments next year. CIC has already attracted massive criticism at home over its deals in U.S. firms, which have been battered by the credit crisis, with its stakes in private equity house Blackstone Group (BX.N) and Morgan Stanley (MS.N) diving in value. One of the sources said both CIC and SAFE would focus more on overseas investments in fixed income areas rather than equities deals in 2009.

Right now it actually seems like China isn’t willing to any risks period. That includes buying bonds with some credit risk. Over the past few months, China seems to have bought little other than Treasury bonds — and perhaps some German bunds and other high-quality Euro-denominated bonds.

It is mathematically impossible for China not to account for a very large share of the Fed’s custodial holdings of Agencies — and those holdings continue to fall. They are now down for the year. They were way up in July, so this is a huge swing. And conversely the growth in central banks Treasury holdings is truly incredible. Think of a $450 billion increase in a year — an increase far in excess of the increase in 2004 when it seemed like Japan was buying every Treasury bond it could find.

I would bet that the CIC is privately pleased that SAFE took a loss on its investment through TPG in WaMu. TPG apparently wanted the CIC to participate, and the CIC said no. SAFE didn’t. George Chen again:

Sources said TPG initially approached China Investment Corp, lobbying the country’s official sovereign wealth fund to become a major limited partner of its new private equity fund. CIC, which was set up by the Communist government last year to earn higher returns on a $200 billion portfolio of its foreign exchange reserves, declined the offer mainly due to concerns about investment risks and poor prospects of U.S. markets, the sources said. Instead, TPG’s dealmakers contacted SAFE and the foreign exchange regulator agreed on condition that TPG would also jointly invest some of its own money in the WaMu deal, the sources said.

SAFE’s associated losses should make it a bit harder for SAFE to argue that it can knows how to manage risk more effectively than the CIC.

SAFE can point to the CIC’s ill fated investments in Blackstone, Morgan Stanley and the Reserve Primary Fund. But the CIC can now point to SAFE’s losses on WaMu — and its (still hidden, I think) mark-to-market losses on its broader equity portfolio.

30 Comments

  • Posted by Observer

    The CCP really should market their Treasury holdings to domestic investors, who would actually find use for them.

  • Posted by Diogenes

    Unfortunately, TPG and its uber salesman, Bonderman, are better known for their money-raising skills and outsized arrogance than investment acumen. Their China fund, now a pan-Asian fund, Newbridge, has never made money but continues to raise money. Perhaps the bright side of the financial crisis is that it will clean out bad institutional investors — both the GPs and the LPs.

  • Posted by jo6pac

    Well if that doesn’t beat all, we build them up and then in the time of need they won’t help. I think this country has run out of suckers except us the tax payer. Thanks Brad, as I get closer to the ground for the storm that’s coming.
    jo6pac

  • Posted by Albion

    When comparing MAJOR FOREIGN HOLDERS OF TREASURY SECURITIES (November 2007 October 2008) it is worth noticing that the major contributors to the USA TB purchase, Japan and China are relatively steady in their holdings.
    A surprising upsurge in rates of changes in the purchase of the US treasury is coming from UK and the Carribean.
    Could someone help me to understand?
    http://www.ustreas.gov/tic/mfh.txt

  • Posted by bsetser

    the rise in the UK’s holdings actually reflects purchases made by china and the oil exporters (but more so china). the tic data is based on the initial sale to a foreign investor, so if a european bank buys a treasury that it then sells the next day to china, it registers in the us data as a sale to private investor in europe. that gets adjusted when the annual survey of portfolio investment comes out. look at the historical data on the tic site … especially at the breaks in the data series in june 07, june 06, june 05, etc

  • Posted by Ying

    Albion:

    Perhaps you should ask the five to ten biggest US banks and ask them where they used their bailout money. From bailout money, interest rate derivative to currency derivatives, it’s all a fog. Americans push China for data transparency, it doesn’t do a very good job itself.

    China is a baby of capitalist country.It copied US for everything in the past and listened to suggestions from American financial elicits in the past till now. Trade surplus and huge dollar reserve is a reality. To claim that it is the intention of Chinese policy to boost export sector is a guess. Who could deny that it wasn’t the intention of US policy maker to force China to keep Yuan down and buy up useless treasury paper to boost US economy?

  • Posted by Albion

    Mr Setser, Mr Ying

    Thanks for your comments they leave me wondering,but reassured.

  • Posted by Albion

    Could someone provide me web addresses in Europe dealing with the same content of information as the various Fed web sites, the US BEA or the US treasury capital system?
    I realise that we in Europe we are fortunate enough to be able to rely upon the in depth knowledge of banks chartists and economists enriched by the savvies bonds dealers but we are at loss when looking at the ECB websites and more unfortunate when perusing in the central banks websites?

  • Posted by texalope

    So what? They are proving themselves to respond to losses with fear, just like most people.

    The irony is that as prices fall , asset prices have less risk embedded in them.

    If you believe this crisis means the financial system as we know it is done, then the right move is to become ultra conservative.

    If you believe this is business as usual, and the world is not coming to an end, then investment opportunity exists.

    I believe in cycles. Right now we are sowing the seeds for the next boom. Cost of borrowing is going down. Cost of quality assets have gone down.

    The same income producing property next door to me , producing the same income it produced last year, is selling for %30 less. I can borrow for 1/3 lower interest yet generate the same cash flow. Business logic tells me this is a buy. Fear of the future will hold me back. Fear seems like an illogical reaction.

    Common stock in businesses that have been around for a long time with competitive advantages that have not been eroded are selling for 35% to 50% less than last year. Their cash flows may be down but not proportionately. If I had the money it would make sense to buy the business. Certainly, the opportunity to buy a fractional share in the stock market is reasonable.

    The Chinese are not the only investors in the world with capital. I predict that INVESTORS with cash will swallow hard and step up to invest in logical investments at attractive prices(does that seem like I’m going out on a limb).

    I also predict they will make money investing at these price levels.

    So if the Chinese want to invest in low return investments to preserve capital, let them.

  • Posted by Mrjacket

    Be cautious of renewed optimism and a Jan, Feb, March rally. Gailbraith reminds you in his Crash of 1929 that giant events of this nature are historical and repetitive.

  • Posted by texalope

    I’m not talking about a rally or timing or optimism. I’m talking about buying assets that throw off cash at low prices.

    They can always go lower, but I consider this an excellent entry point that will make money over time.

    If I were prescient enough to expect a fall, I’d throw in some shorts. I don’t INVEST that way.

    Ben Graham, in the “Intelligent Investor”, devotes a full chapter to a discussion of investing versus speculating. It is worth reading.

    I must admit, sometimes I throw in a quick bet in the stock market, but I do it with my eyes open . I call that speculating.

  • Posted by bsetser

    Albion — there is no real analogue in Europe to the TIC. The best source for BoP data for the eurozone is the ECB’s monthly bulletin. I presume the data can be downloaded in an excel file as well — tho I don’t know the web address. the UK’s BoP data is shockingly bad — at least when it comes to tracking capital flows (the current account data is fine). I dug around a bit and didn’t find anything useful there, as the data is too highly aggregated to be at all revealing.

  • Posted by credulous_prole

    Texalope:

    I saw a recent deal with 14% coupon and 120% due at maturity, with recourse of course to all PPE. If that’s cheap cost funds, please don’t show me expensive!

    Btw, the US economy will fundamentally change after this “crisis”. Brad’s been articulating this for a while.

  • Posted by DJC

    China to use US Dollar reserves to build-up strategic oil reserves

    http://uk.reuters.com/article/oilRpt/idUKPEK29764020081229

    BEIJING, Dec 29 (Reuters) – China plans to use the fall in global energy demand to boost its fledgling oil reserves against future supply shocks, as it speeds up development of nuclear and wind power and cuts reliance on coal, a top energy official said.

    Among the plans, China will push ahead with building the second phase of its strategic oil reserves, having largely completed the first, Zhang said.

    The first two bases, at Zhenhai and Zhoushan, were up and running more than a year ago. Construction of the Dalian facility, the fourth base, was due for completion by year-end.

    Industry sources have told Reuters that around 7.3 million barrels of oil were injected into Huangdao in early November and more stockpiling was planned in December and January.

    The sources said more than half of November’s oil came from Saudi Arabia. This tallies with Chinese customs data showing a 70 percent year-on-year rise in imports of Saudi crude last month.

    China has completed planning of the second phase of government storage facilities that could hold up to 26.8 million cubic metres of oil, or some 170 million barrels, but has not disclosed where the facilities are or whether construction has begun.

    The size of China’s storage will still be a fraction of the U.S. Strategic Petroleum Reserve, the world’s largest emergency oil stockpile, which holds 700 million barrels of crude.

    But China is second only to the United States as a consumer of oil and its rapid stockpiling effort, begun only two years ago, has the potential to soak up a lot of surplus crude oil.

  • Posted by Thomas

    Hey Brad:

    Do you know Will Cornell at the CFR?

  • Posted by Bruce Webb

    December 31st, 2008 at 2:44 am
    Albion responds:
    When comparing MAJOR FOREIGN HOLDERS OF TREASURY SECURITIES (November 2007 October 2008) it is worth noticing that the major contributors to the USA TB purchase, Japan and China are relatively steady in their holdings.
    A surprising upsurge in rates of changes in the purchase of the US treasury is coming from UK and the Carribean.
    Could someone help me to understand?
    http://www.ustreas.gov/tic/mfh.txt

    December 31st, 2008 at 2:49 am
    bsetser responds:
    the rise in the UK’s holdings actually reflects purchases made by china and the oil exporters (but more so china). the tic data is based on the initial sale to a foreign investor, so if a european bank buys a treasury that it then sells the next day to china, it registers in the us data as a sale to private investor in europe. that gets adjusted when the annual survey of portfolio investment comes out. look at the historical data on the tic site … especially at the breaks in the data series in june 07, june 06, june 05, etc

    Well I have to defer to Brad here, he is after all the acknowledged expert on this stuff. But let me pose two questions. One what is China’s motive for using European intermediaries? Because the numbers show they are clearly also buying on their own account. And two what proportion of that huge run up in UK and Carib Banking holdings is really due to China? And more to the point how do we know the answer? Because on my (admittedly limited) knowledge of these matters these institutions are not exactly models for transparency.I

  • Posted by bsetser

    Bruce — you need for much of a motive. A lot is just time zones. London is open at the CoB in BEijing, and as someone there explained to me, SAFE learns at the end of the day how many $ the PBoC bought and thus how much it needs to buy. European banks know they need inventory to meet expected chinese demand, so they replenish when the US opens … and so on …

    A very large share of the UK run up is China in my view. I’ll be posting a lot on this in early January as I have a paper on China’s holdings coming out. I haven’t looked closely at how the survey revises the Carribbean holdings but my strong sense is that China buys through the UK not the Carrib.

    My method for looking at all this is to see whose holdings get revised up when the survey revises the UK’s holdings down. It turns out that the china accounts for far more of the UK revision than the Gulf. That surprised me initially, but it is a consistent pattern.

    finally, i don’t know will cornell.

  • Posted by bsetser

    oopps — the last post should have started “you do NOT need much of a motive” it came out a bit garbled.

  • Posted by Yoda

    “China has lost its appetite for risky assets”???

    “No, there is another.” USA Treasury…

  • Posted by GloomBoom

    With China’s aversion to risk the U.S. must make sure that confidence remains in bonds. Is this the next bubble? If so, we are toast!

  • Posted by Yoda

    Is huge USA Treasury bubble about to burst? Is Gold preparing to launch another bull market? “The dark side clouds everything. Impossible to see the future is.”

  • Posted by Bruce Webb

    Thank you Brad. Because I really want to understand this stuff.

    But I have to wonder if time zones really explain the commission involved. I assume the British/Carib Banks are not operating for free. Which is to say the various Chinese governmental and other entities are buying Treasuries for yields that are hovering right from zero then down. That they are then paying some additional premium to these off shore entities just to avoid having some official banking branch presence in the Cayman Islands or the Isle of Man still seems odd to me.

    Like I said I am a naif in these matters but it would not seem hard to find some trader willing to execute orders from some high rise in Shanghai even if it was a little late in Chinese time. Why are they throwing even a fraction of a percent of expected yield towards these second or third parties?

    And yes there is a certain amount of snark here. But I am not quite getting it and Brenda Rosser (a Tasmanian contributer to EconoSpeak and a much more serious person/commentator than me) is not quite getting it. And as we see commenter Albion is only kind of getting it. Which suggests to me that lots of other people are scratching their heads. Under your formulation the Chinese central banking entities (and I don’t pretend to understand the difference between SAFE from TPG from CIC) in investing in US Treasuries through UK and perhaps Carib Banking Centers are paying real money for perceived value in doing so. I just have a hard time seeing that value considering current yields.

  • Posted by Twofish

    Q: One what is China’s motive for using European intermediaries? Because the numbers show they are clearly also buying on their own account.

    One possible answer which might sound silly is time zone. London and Beijing have overlapping business hours, whereas New York City and Beijing do not.

  • Posted by Twofish

    I posted before I saw Brad’s reply, but I’m glad to see that someone else sees the same thing. Time zones make a huge difference in trading.

    Webb: But I have to wonder if time zones really explain the commission involved. I assume the British/Carib Banks are not operating for free.

    London is a very liquid market so the prices you get for Treasuries via London aren’t that different from the one’s you get in NYC. The London financial services industry is dominated by American banks.

    Webb: Like I said I am a naif in these matters but it would not seem hard to find some trader willing to execute orders from some high rise in Shanghai even if it was a little late in Chinese time.

    Trading is a very communal activity so things are suboptimal if you don’t have a group of people up and active. Just to point out something silly, what do you do if you are in the office at night, and you double click on Excel and nothing happens.

    Webb: Why are they throwing even a fraction of a percent of expected yield towards these second or third parties?

    London is a primary market for Treasuries so the yields you get in trading from London aren’t different from trading in New York. If the prices are even slightly different, then a lot of automated computer trading kicks in to wipe out the difference.

    People aren’t buying and selling Treasuries in London to resell in NYC. They are buying and selling Treasuries for their own accounts.

    Also this is the reason why the trades go through London and not Hong Kong.

  • Posted by bsetser

    Bruce — see 2fish’s post. China isn’t commissioning the banks to buy for it. The banks buy Treasuries for their inventory knowing that China is a likely buyer. The spreads on all this are miniscule. If the banks were charging too much, a team at SAFE would stay up late and wait until the US markets open.

    If you doubt my interpretation, look at the historical data series on treasury holdings — not the current data. it is just below the data on current holdings on the TIC web site. That table shows the scale of the revisions that come when the data from the survey is made available. The UK goes down and China goes up. Also look at the Treasury’s explanation (on the TIC site) for why the Fed’s custodial holdings sometimes rise by a sum larger than implied by the official purchases in the TIC data.

    Or talk to a Treasury trader in london ….

  • Posted by Bruce Webb

    Well my response is somewhere in the system (because it claims I have already posted). Whether it shows up or not is an open question. In short the time zone suggestion doesn’t add up. London and Beijing are separated by 8 hours and so don’t have much overlap in business. Two even if this made any kind of sense by and large the Carib Banking Centers are in the same time zone as NYC. Why not execute the trade there? Three, the idea that the Chinese would direct billions in trading to overseas institutions because they didn’t have Desk Support staff for a corrupted Excel file is just silly.

    I’ll look at the revisions in relation to the overall numbers of direct purchases. But as yet I don’t find the case compelling.

  • Posted by bsetser

    bruce — china accounted for a huge share of the 07 downward revisions (and there is a high correlation with the uk’s downward revision and the upward revision in official holdings as well). what part of that isn’t compelling? I am not following.

    I’ll post graphs soon that i think make this crystal clear. the downward revisions in the combined uk + china holdings are actually fairly small and declining — as one would expect if china accounts for most purchases thru the uk.

    Moreover, London is working at 5 pm beijing time when SAFE gets the cash the PBoC bought during the day. New York isn’t. When Beijing wakes up in the morning, New York has already closed (i know this b/c scheduling interviews with contacts in china is pain — but less so b/c i can to the interview from home at night)

    I am not convinced re the Carrib.

    If China truely wanted to hide its holdings it could — it just would need to make greater use of private custodians/ private fund managers.

    as it is, china buys treasuries and agencies in london trading hours and then hands them over to the fed for custodial safe keeping, and thus is the main reason why the fed’s custodial holdings often rise by more than total offical purchases. look at the explainer on the tic web site. it leaves out the country names but describes the process.

  • Posted by bsetser

    by not convinced re: the carrib i meant that I am not convinced that carribean purchases reflect Chinese demand. I suspect they are more tied to us hedge funds. long treasuries has been a reasonably popular bet recently …

  • Posted by Twofish

    Webb: In short the time zone suggestion doesn’t add up. London and Beijing are separated by 8 hours and so don’t have much overlap in business.

    There is enough overlap to do business.

    Webb: Two even if this made any kind of sense by and large the Carib Banking Centers are in the same time zone as NYC. Why not execute the trade there?

    There’s very little real trading that goes on in the Carribean. For the most part, Carribean islands are just legal shells, and most of the hedge funds that are legally domiciled in the Carribean don’t do any real business there.

    Webb: Three, the idea that the Chinese would direct billions in trading to overseas institutions because they didn’t have Desk Support staff for a corrupted Excel file is just silly.

    It’s a major consideration. You really need people on call while doing trading because things do break. Yes if you pay enough money, you can have a Excel desktop support team on call late at night, but it’s probably much more expensive than to just do the trade in London.

    There are other reasons. If you can get the transactions settled by 5 p.m., you can start running overnight reports. A lot of these reports are extremely time intensive and a few extra hours to do reports makes a big difference. Also if something goes wrong while you are running reports, you have time to fix things before everyone goes home.

    There is also operational security, you just don’t want one person or a small number of people doing multi-billion dollar trades. You want lots and lots of people in the office, each looking over everyone else’s shoulder, to make sure that no one makes a mistake or does something odd.

    Finally, there are things like “Herstatt risk” (google for it). Anytime there is a gap between the time you place an order and the time the order gets settled, lots of weird things can happen (in 1974, German regulators closed a bank before NYC could open, and this caused huge amounts of problems as you had half open transactions.)

    Just to give a hypothetical of the type of thing that people worry about.

    Suppose at 5 p.m. orders are given to buy or sell $X billion in treasuries when NYC markets open. Then at 7:30 a dirty bomb goes off in the Saudi oil fields or there is a terrorist bomb in London or a megabank collapses somewhere in the world. If you’ve just left a low level trader handling the situation that does not have the authority to figure out what to do then you are hosed.

    If you can settle the order immediately, and something weird happens while you are executing (whether it is Al-qaeda blowing up a dirty bomb or Excel just not working), you can get everyone in Europe on phone, and scream across the trading floor for your people and fix the problem then and there. If you need a senior manager to make a decision, you can be sure that someone with authority is in the building and probably on the floor, and you can walk over to their desk and pull them over.

    If it happens after hours, then just getting everyone together is going to be painful.

  • Posted by anon1

    Re discussion on Chinese dealing in Treasuries,

    Brad and Twofish are correct – Brad on the data, and Twofish on the way the market works.

    Bottom line is that London is the optimal point for China’s settlement of its US cash position, due to the combination of established market liquidity and time zone continuity. China wants liquidity and competitive offerings, which means active dealer competition as established in London.

    As pointed out, the Carribean is a bit of a joke to consider in this sense, meaning that its a tax shelter domcile for buy siders – not a trading post for sell siders.

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