Brad Setser

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Secrets of SAFE: A trillion of Treasuries here, a trillion there and pretty soon you are talking about real money …

by Brad Setser
January 30, 2009

China has $1946 billion in reserves. The PBoC had another $185 billion in “other foreign assets” at the end of November. Given the fall in China’s reserve requirement, now likely has maybe $160 billion and perhaps less. The PBoC therefore already manages a portfolio in excess of two trillion dollars. The CIC has around $90 billion (less if it marks to market) – as it spent $67 billion acquiring Huijin (China’s existing bank recapitalization vehicle), $20 billion recapitalizing the CDB, $3 billion of China Everbright and $19 billion on ABC. The state banks have at least another $100 billion in foreign assets. Sum it all up and the foreign portfolio of China’s government is north of $2.3 trillion.

Consequently it should be a surprise that China’s government now has close to a trillion in Treasuries. OK, not quite a trillion. But darn close. $860 billion or so at the end of November and – if current trends continue — over $900 billion at the end of December.

China also has $550 billion or so of Agencies, which are effectively now backstopped by the Treasury. That works out to an enormous bet by China’s government on US government bonds.

These are just a few of the conclusions of a new paper, China’s $1.7 trillion dollar bet, that I co-authored with the CFR’s Arpana Pandey.

This paper presents detailed estimates of the growth of China’s foreign portfolio, taking into consideration the increase in China’s hidden reserves. The story is here is simple: China’s reported reserve growth from mid-2007 to mid-2008 understates its actual reserve growth, as the government forced the banks to hold dollars to meet a portion of their reserve requirement. There isn’t any real doubt about this; the PBoC’s reported an enormous increase in its “other foreign assets.” These hidden reserves are now coming down; China’s reported reserve growth now somewhat overstates the true pace of its reserves growth.

The more innovative portion of the paper presents a detailed portrait of the evolution of China’s portfolio over time.* Our estimates of China’s US portfolio are the result of a lot of detective work. China’s recorded US purchases have – until recently – clearly understated China’s real purchases. The challenge was working out a way to estimate, China’s true purchases using the US data.

It turns out that the US data on the UK’s purchases (and to a lesser extent Hong Kong’s purchases) of Treasuries and Agencies hold the key. The adding the purchases of Treasuries and Agencies to China’s recorded purchases of Treasuries and Agencies produces a total that tracks the growth in China’s foreign assets reasonably well.

The United States’ annual survey of foreign portfolio investment confirms this; every year the survey leads to large downward revisions in the UK’s holdings of Treasuries and large upward revisions in China’s holdings. This shows up clearly in a plot of countries Treasury holdings over time.

If the US Treasury produced a similar data series for Agencies, it would show a similar pattern. Trust me on this.

The sum of China’s recorded holdings and the UK’s holdings ($1050 billion at the end of November) offers a pretty good upper limit for current Treasury holdings. For a more refined estimate, add the change in the UK’s holdings since the last survey to China’s reported holdings. And to improve on that, assume that the revisions associated with the next survey will match the revisions associated with the last survey. The June 2007 survey reattributed 60% of the rise in the Treasury holdings of the UK and Hong Kong to China. We assumed the next survey will produce a similar adjustment … **

We use this methodology plus the monthly data on Chinese, UK and HK purchases to estimate China’s “true” US portfolio. We effectively distribute the increase in China’s holdings at the time of the survey data over the course of the year in line with the pattern of UK and HK purchases over the course of the year.

The resulting model – no surprise – shows a big recent jump in China’s Treasury holdings. And a noticeable dip in its Agency holdings. Dean, Areddy and Ng nailed this story. Last fall China lost confidence in any US debt that doesn’t have explicit US government backing.

We did two other things with this data. We looked at the rolling 12m change in China’s US portfolio*** relative to the growth in China’s reserves, and we looked at China’s purchases relative to all central bank purchases.

Our estimates for the growth in China’s US portfolio (estimates derived, it should be noted, entirely from the US data – China’s reserve growth isn’t explicitly a variable in our model) is quite consistent with the growth in China’s reserves and the growth in China’s portfolio that would be require to maintain a 67-70% dollar share in China’s portfolio.

A couple of additional comments:

The fall in China’s purchases from mid-2003 to mid-2004 is no accident. China almost certainly reduced the dollar share of its reserves to around 70% at some point between the June 2003 survey and the June 2004 survey. The very strong growth in China’s current US holdings likely is a bit overstated. The rise in China’s Treasury holdings is very real. But some of that rise is likely explained by a decline in China’s holdings of other kinds of US assets, and it isn’t clear that we have picked up all of the fall.

We also plotted China’s average monthly purchases of Treasuries and Agencies against our estimate for the official sector’s average monthly purchases of Treasuries and Agencies (these estimates were produced using a similar methodology to the methodology used to estimate China’s purchases, i.e. we adjust the flows through London to anticipate the survey revisions; and we averaged monthly purchases over the last 12ms on a rolling basis). If we are right, the official sector’s average monthly purchases of Treasuries and Agencies more or less matched the US monthly trade deficit for most of the last 18 months, and China accounts for about ½ the total. More than ½ actually.

The same data can be presented as a rolling 12m sum. I find it hard – based on this analysis – not to think that Chinese demand had no impact on the US fixed income market. Chinese purchases steadily increased over time. And over the past 18 months, they have been huge …

I get a sense the level of concern about China’s financing of the US has increased significantly. Some of that reflects the fact that the US Treasury data now shows that China now holds more Treasuries than Japan. There also is a sense (inaccurate in my view) that the huge increase in the Treasury’s borrowing implies more borrowing from China. Many now argue that the US needs to refrain from criticizing Chinese policies is dislikes in order to assure continued Chinese demand for US debt. That, incidentally, is evidence that China already holds enough debt to influence US policy – the overarching assumption is that other buyers wouldn’t step in if China stepped back. At least not at the same price.

I have spent a lot of time trying to track China’s portfolio – and almost as much time thinking about how China might try to turn the United States’ need for Chinese financing into political leverage. And strangely enough, I am a bit less worried than before.

Perhaps that is because China actually surpassed Japan as the United States largest creditor – counting its holdings of Agencies – a long time ago.

Perhaps it is because I no longer find China’s portfolio to be quite the mystery it used to be.

Perhaps it is because China’s current portfolio choices appear driven by a desire to avoid (RMB) losses, and so long as China pegs to the dollar, holding Treasuries poses few risks. Remember that in RMB terms, China’s pound, Australian dollar and Korean won portfolios have not performed well recently. And central banks tend to look back not forward.

Perhaps it because both the United States’ trade deficit and China’s reserve growth are coming down. The recent surge in China’s Treasury holdings reflects a reallocation of China’s US portfolio more than anything else. Once that reallocation is done, SAFE’s Treasury purchases will slow – independently of the words Treasury Secretary Tim Geithner uses to describe China’s policy of intervening heavily, if necessary, to maintain the RMB’s current value against the dollar. So long as China is running a current account surplus it will be financing the world, but that outflow will not be channeled through China’s central bank.

And perhaps it is because China hasn’t been buying dollars because it likes the dollar or because it likes US policy. It has been buying dollars because it has pegged to the dollar and runs a large current account surplus. Absent sustained hot money outflows, that implies ongoing Chinese purchases of foreign – and likely US – assets.

But above all it is because I was extremely worried in the past.

Not so long ago, the global pattern of private capital flows was completely at odds with the global pattern of trade flows. Private capital was flowing to countries with trade surpluses that didn’t need financing, not to the US which did. Huge sums were flowing into China. Only extraordinary intervention by emerging market central banks prevented a dollar crisis …

It felt like the US was living on borrowed time, with a large external deficit than clearly could not be financed in the private market.

And now, well, demand for dollars has rematerialized even as the fall in US consumption has reduced the United States’ need for foreign financing. Oil’s fall also really helps. The trouble spots – it seems to me – are now those emerging markets with large financing needs and limited reserves …

Do let me know what you think of our paper.

* The estimates for China’s total foreign portfolio were produced entirely using Chinese data. With a bit of math, it is easy to estimate the purchases of US assets that would be needed for China to maintain a constant dollar share of its overall portfolio. The estimates for China’s US portfolio were produced entirely using US data. And what’s more, they more or less match my estimate – based on the Chinese data – for China’s dollar portfolio. That makes me think, immodestly, that the methodology Arpana and I developed to track the evolution of China’s foreign portfolio really works …
** China accounted for well over 100% of the UK and HK’s purchases of long-term Agencies in the last survey (this is possible if China is buying some of the existing private stock). We assumed it will account for a bit lower share in the next survey. This is a judgment call – one which no doubt was influenced by our knowledge of China’s total reserve growth. Mechanically applying the model was producing too large an increase in China’s portfolio.
*** We added the flows implied by our adjusted data on Treasuries and Agencies to the unadjusted data on China’s corporate bond purchases. The survey has revised China’s corporate bond holdings down not up – a result that likely reflects China’s use of non-American custodians for its corporate bond portfolio (the New York Fed doesn’t hold corporate bonds for foreign central banks, only Treasuries and Agencies)
**** To be clear, China as a whole is still running a large current account surplus and thus providing substantial financing to the world. Right now though China’s surplus is financing the build up of private Chinese claims on the world (i.e. offshore bank deposits) rather than Chinese reserves.


  • Posted by Rien Huizer


    By the time I had scrolled through all those irrelevant comments by certain people abusing this blog for promotion of their own, I had almost forgotten what your paper was about. That while I remembered agreeing with it, mostly.

    Glad to see what your concerns were with the situation we had only a short while ago. Can I condense that to: it would have been a problem if a very big part of the emerging economy would park all its savings in the US. With lower oil prices etc, some of those savings will shrink, while the US itself is saving more. That China has in fact more USD assets than earlier estimated, and that most of that is extremely risk averse should not worry.

    Indeed, the most damage a country in the situation of China can do is to reduce the risk preferences of its investment activity. Now that has been done, all that can happen (barring an attempt to do the impossible switch into other currencies or commodities) is that China increases its risk appetite, which would be extremely welcome.

    It took a while, but once you realize that, all that talk about the Chinese buying GM becomes somewhat relevant to this discusion. Not much though: twofish is right: the US would not approve and China would probably have hundreds of other businesses it would rather buy. However, someday someone will have to figure out what is the difference between China buying something sensitive (a political issue) and a Chinese firm buying something equally sensitive. Because, if and when China’s risk appetite grows, should they be rstricted to portfolio investments and junk? No way to treat a friend..

  • Posted by bluecho


    Excellent work! Concur to your conclusions of the paper.

    Just my two cents on the topic:
    1. For the coming few years, RMB/USD peg will stay put, which means China’s surplus will continue to finance US debts. As for the allocation among treasury, agency and corporate, I don’t see China to change its current practice until the US economy and financial market firmly back on their feet again.
    2. Nonetheless, the real question is the amount of the surplus. IMHO, it would be well-advised for China to reduce its surplus for the coming years. Surplus is the outcome of China’s overall economic strategy and monetary policies, rather than target. China had some real bad experience in managing reserve, with appalling losses and domestic agony of such losses in 2008. Why accumulate surplus at all? China no longer needs it for safety reasons given the huge balance and employing surplus in financial assets is a real pain not only in the sense of how difficult to do a decent job with all the ongoing uncertainties in world (or to say US in a large sense) economy and financial market, but also how much bad press it has generated (I am not only talking about China domestic complains herein, just look around and see how lack of respect-no I am not talking about gratitude, US has shown to its largest debtor so far. Geithner’s pretty face just flashed). The answer to the question is not to resolve but to mitigate. Running through the equation, my answer would be aggressive fiscal policy that can either step in to absorb the declined demand for export products or consume most part of the current surplus through more import. Except infrastructure, social security, education, medical systems are all areas the government can splash upon. After all, if it’s hard to spend your money wisely, why not spend it at home.
    What do you think, Brad?

  • Posted by Indian Investor

    I’ve often discovered that when you write down some analysis, it helps to clarify thoughts a great deal. So, as I mentioned in my previous post, it could be that Brad Setser is just an overspecialized person who doesn’t have any actionable policy steps for the US Government. Alternatively, things could be totally different. The simple and basic things are ignored deliberately, and the overspecialized knowledge is utilized to create a perception that supports some action, or result.
    When Brad Setser argues that China has been following a mercantilist policy, and also that the current account imbalances led to the credit crisis, what is the proposed policy action step from this?
    Brad Setser has also made a case that the US should increase its exports to China. What is the policy action step from this?
    A third a important point was made in the paper on sovereign debt, viz. that the US should not rely on financing from the PBoC. So what action should be taken from that?
    Further the sovereign debt analysis has been refined in the last few days. The new Brad Setser conclusion is that the US deficit no longer relies on financing from China. The US can now finance its deficit from the “private market”.
    Brad Setser supports Geithner’s demand for a stronger RMB with his own reasoning, and also points out it was part of the Presidential election campaign.

    LOL 🙂 now I think I finally know what Brad Setser is REALLY recommending to the US Government

    Add up those four things, and reason with the well known China situation in the ongoing crisis …

    LOL 🙂

  • Posted by Albion

    Very tedious and comprehensive following up on a major US current account provider.
    Save Japan one may notice an inflexion point in the growth rate (as of beginning 2008)
    Should you plot the increasing needs in treasury how would you explain for the steady decline in yield of the TB’s?
    When looking at the TIC report one may see an adjacent contributor to the London funding that is the Caribbean’s no mention, no correlation is established with China contribution flows?.
    As one of the outcomes:
    Dependency of the US CA financing through China
    A zero sum game as China surpluses are US current account (would the creditor remain as a steadfast financier in a shrinking global trade world?)
    Besides the TARP TIC conversion how else would you finance the CA ?

  • Posted by cdr

    There is a huge wall right here that’s preventing any reasonable solution to situation at hand. At first glance it looks like Chinese.

    Forceful interest looks to book the cost to the (notional) nation state’s accounts, making things worse. The politicians have no idea whatsoever on both, the cause and solution. But that surely hits expectations right on the spot.

    There is -many times over – NO equity in the biggest US, UK and almost certainly in other western BIG banks. Their owners are their debt holders. Some of them hidden under deposits, others are not. They knew and they know what exactly was being financed – exactly. It is they that need a serious hair cut. No way around that. The numbers just won’t add up. They can’t. Even if you throw 1, 2 or $4tn into this hole, there will always be more. The source is just never ending. It is a scheme.

    If they don’t like the hairstyle, then it is they not their »children« that need (a healthy dose of) nationalization. Bad banks and worse, guarantees, please. There’s no fidic or other backstops behind that, just many bald taxpayers. We went past that stage long time ago. Destroy all the good banks left because they were smaller? By the time the US gets to this stage, no debts will perform. Wake up.

    We can debate the same China – US flows topic in 350 separate different ways. UK exposed is great tho partial with regard to the whole truth. There is other stuff in the UK that went (and goes) on and is not touched. Then there’s stuff going on in other places. It’s exactly where the private hats are changed into the public one and back.

    If the grid locking US-Chinese nominal flows were to decrease, the Chinese + large parts of the world, Europe included, first need an assurance (not through the AIG), that there is no next trap that’s forming or formed.

    There is no such assurance. The intra-administration wars/games make it look like (increasingly) that the reverse might be true. This is not the battle that anyone wins.

    THIS is the problem.

    If not attended, the name-callers prevail. Then everyone looses out first – before even they will be forced to follow. No debts will perform, deflation, depression, whatever… Then what? It’s not about debt though, it’s about who makes the decision. But that’s an appearance as well. Both roads are quite clear at this point. Name-calling is that wall, tear it down, behind lies the other way and this is the crossroads.

    It may be that the $500-700tn are in fact saying that the journey was baked in the cake some time ago. Some of the recent things made me hope differently. Name calling included.

    For grown ups – taking a hair cut should be a voluntary act. Especially when everyone else is bald already, the hair grown has tied up everyone’s feet – app. ten times over and lastly, the hair dressers are many, all clueless about how to use scissors.

  • Posted by gillies

    continue the following series : 2, 4, 8, 16, 32, 64 . . . . . .

    the specialist says : 128, 256 . . . . .

    the hurler on the ditch (non participating spectator) says 0 because the series is obviously monitoring an unsustainable bubble. sometimes the irrelevant is irrelevant. sometimes the irrelevant is a step back into the wider context needed to make sense of the detail.

    reserves in general are for the purpose of stability, to bring into play in order to cope with sudden changes of fortune, or speculative attacks. the growth of chinese reserves has gone on to a point where they threaten to create instability through fear of sudden change.

    this is not just china and the u s – any two countries whose economies had such a relationship would need to talk, and talk regularly. the problem is not the fact of the chinese dollar hoard, but the size of it in relation to the real trade that is going on.

    the world is seeing a loss of trust, in general. the gold bugs may be right, may be wrong, but are part of a world-wide hunger for real stuff that you can be sure will still be there when the screen goes blank.

    we are all going around like madoff clients, or iraq combat veterans, hyperalert to where the next nasty surprise is coming from.

    chinese and american economy managers would do best to do a deal – some kind of understanding that the stability of the treasury market is in both their interests.

    it is completely inappropriate for governments to think like individuals or speculators. they need to engineer a return to contact with the real global economy. the global financial superstructure needs to be lowered in proportion to the dimensions of the boat. the oil market for example needs some cap on the relationship of speculative buying and selling to real activity. no essential commodity should be jumping up and down 10% a day.

    the debate over ‘savings glut’ and ‘excessive consumption’ does not need to be resolved. the dancing partners need to keep closer together and keep in step. even if the future is to be protectionist – this too can be done with mutual respect and consideration.

    with the global economy into the era of the great contraction, it would be appropriate for all of its finance, debts as well as reserves, to contract in step and in orderly fashion.

    whether it is treasuries or electric kettles, oversupply will only lead to trouble.

  • Posted by bsetser

    Rien — The problem with Chinese purchases of equity right now is that it would be the Chinese government purchasing equity, and i just don’t quite see how that works. Wouldn’t there be a sense in China that Chinese investment in a US firm that wasn’t producing in China was coming at the expense of Chinese firms? And wouldn’t there be fears that any Chinese purchases of US firm would be done to pursue China’s economic development goals? China is a development state; that seems to make it hard to have heavy Chinese state investment abroad … This was one of the core issues around the CIC (the other was that the CIC was in effect a way of supporting the exchange rate and keeping the surplus up).

    But I agree that there a reallocation back towards Agencies/ bank debt/ other kinds of debt with a bit of credit risk would be helpful at this stage. The big residual risk is that China would decide that Treasuries aren’t safe and allocate away from them, but the obvious questions then are where can China go without disrupting the market it is moving into/ can china do this without slowing the US/ and would China risk doing something that would risk a further downleg to its exports now?

    Bluecho — I agree with your analysis.

    Albion — sorry about the tediousness of the analysis. I wanted to document the basis for my estimates. That way I can refer back to the document as they are updated without having to explain where my numbers come from. I agree that a plot of foreign purchases and Chinese purchases would be interesting. It tho would show that us sales started to exceed foreign purchases rather significantly this fall.

  • Posted by bsetser

    Indian investor — the volume of your comments (and the fact that they rarely are on topic) is interfering with the discussion here. I can address this in a lot of different ways, some rather draconian. But my preferred solution would be for you to exercise a bit of restraint.

    As for my policy recommendations — i don’t really have many new ones compared to the ones in “Sovereign Wealth and Sovereign Power.” Neither the paper on the Gulf nor the paper on China were intended to be works of policy advocacy. Rather they were meant to help illuminate some of the shadows of the international financial system.

  • Posted by bsetser

    gillies – i like the term “great contraction”;

    not quite sure tho if it is possible to for the great producer and great consumer to keep in step if the future is protectionists tho … seems hard.

  • Posted by Ian R. Campbell

    Not everyone – including Wall and Bay Streeters –focus on the quantum of $U.S. held by the Chinese government, and the possible consequences of this. Personally, I believe China’s accumulation of U.S.$ equivalents likely is a world changing event. This massive amount of U.S.$ will enable the China to build infrastructure, further their internal economic development, and acquire assets outside China that China considers strategic.

    I consider this a very useful post. I began to write daily posts to my own blog,, about a week ago. I referenced this post there today and strongly recommended all of my readers click on the link I made in the post to this article.

  • Posted by bsetser

    Indian investor — so now you are insinuating that I am a paid shill? I rather thought I was a think tank so I could do the work that I wanted, without the constraints that come with some other kinds of employment. I am pretty confident that there is no market value to backward looking estimates of china’s reserves. The folks in the Agency and Treasury markets knew that China was shifting its portfolio long before the TIC data came out …

  • Posted by Hedging Risk


    In the last TIC data, it appears that China is not only starting its liquidation process in the agency’s, but that it is moving its US T exposure from the longer end to the shorter end. A scary proposition, as it concentrates their ability to exercise more and more control in our auctions markets.

    This double whammy appears to be building a massive short term decaying debt pile that will need to be rolled in larger and larger size. While that is exactly what we needed in the near term (historic issues of late), the fact our largest holder of US T’s is now bankrolling us with the shortest of time windows should open some eyes. This is like a giant SIV at this point.

    Is there anyway to track the growth in the short term end of their holdings outside of the TIC? How long will it take your model to spot a turn in Chinese holdings when they start selling Treasury’s?

    If China uses its holdings to build a massive short term roll, that becomes a weapon of mass economic liquidity, they can use at any time, all on its own. Are you looking for concentrated holdings at this point?

    Thank you for taking the time to share, and if necessary, please go Draconian. Maybe an option so we can auto filter any poster from the forum. He is attempting to hijack our forum and turn it into his own ego driven soap box.

  • Posted by Ying

    I am thinking about an exit strategy for China and US. Maybe China and US can do a deal. China uses its treasuries to buy existing shares of Chinese firms held by US corporations. This may not amount to $2 trillion but it sure will reduce the amount of treasuries outstanding. For most Chinese, China doesn’t really have the ability and interest to go abroad to expand their business. Their focus should be development at home especially mid and west area of China. It doesn’t make sense to earn extra money from developed nation since the globalization is neither sustainable nor efficient in many ways. From US side, they don’t have to worry that China will dump US dollars to threaten their economy. It also satisfy protectionists demand to focus more at home. Is this a good idea?

  • Posted by Murph


    I was never able to understand why the monthly TIC figues didn’t match the annual survey figures until I began reading your site regularly – and your paper explains your methodology and reasoning very clearly.

    To what do you attribute the deliberate lack of transparency on information about China’s holdings ? Does the misdirection really benefit anyone ? (Especially as your detective-work becomes more widely publicized ? )

    (P.S. – found a couple typos in table 2: “4,023” should be “403” and “1,694” should be “1,695”.)

  • Posted by Indian Investor

    Brad: I rather thought I was a think tank so I could do the work that I wanted.

    Well I’m happy to hear this. What I’m explaining is that usually I can tell very quickly if a report is just written to benefit some private firms, but I haven’t been able to find that in your work. In many cases these reports do contain an appreciable point of view independent of the private benefits. For instance, going for genetically modified seeds does solve the food problem, even if the report is written to benefit some seed companies.FDI does increase competition, capital and employment; even if the report is written by some IMF people at the time of a crisis to facilitate equity purchases at throwaway purchases.
    Now, talking of Geithner, and referring to my analysis of US exports; I don’t see the validity of Geithner asking for a stronger RMB at this point of time, when this will just cause the Chinese market to crash, factories to close; and I don’t know of a single deal on the anvil where something is going to be made in USA and exported to China.
    So I’m insinuating a lot of things about the majority of all IMF economists in history, who have ever written reports with policy recommendations for emerging markets in Asia, South America, Africa, etc. You will see in each of these IMF crisis reports the same tag line … FDI liberalization…followed up with lots of FDI in that country once it’s bailed out.
    Similarly I doubt the conflicts in Gaza, Ossetia and Sri Lanka are anything to do with ethnic identities, and mostly to do with oil reserves and pipelines; so here I’m plainly alleging that all the ethnic identity talk is just for public consumption and the real motivations of that talk are different.
    Since I’ve recently discovered that lots of IMF economists with the best pedigree education, and lots of generals and presidents etc all indulge in double talk, these days just about everybody is suspect, in my mind. But I need to re adjust my perceptions so that I can go back to accepting what people are projecting, and then suspect them only if something strange comes up.
    Strange things like the Mumbai big burning five star hotels, with terrorists killing some anonymous Jewish rabbis in a back alley house somewhere, a few hundred people in a railway station, and three prominent anti-terror police officers. The whole Mumbai incident is just completely inexplicable to me, and none of the explanations for what happened there are actually making any sense. The reason I mentioned Mumbai is that there are plenty of unexplained mysteries around all the time. You get these completely crazy media explanations for what happened, and then when you think about it, seriously, that explanation just doesn’t make any sense at all.

  • Posted by Indian Investor

    Brad: I rather thought I was a think tank so I could do the work that I wanted.

    Well you would do very well to recognize that the work on Central Bank Reserves and global capital flows, analysis of SWF investments, etc has very strong political implications.
    Your stand has been that the long term current account imbalance led to the crisis. This might very well be a widely held opinion amongst many economists.
    But the practical steps that are being looked at have little or nothing to do with economics, and mostly to do with politics of “clawing” something or other from somebody or any passable pretext.
    China has problems because of factory closures and mass firings. There are many reports of strikes, lock outs and cases where workers are banding up and making a violent attack on the closed factories, smashing everything in sight.
    If China now strengthens the RMB, these problems will intensify so much that the Government might fall.
    And the reason Geithner is asking for this step isn’t to increase sales of Boeings, or anything even close to that. Those are peaceful activities that take a lot of planning, negotiation and effort. The Geithner objective is that if the China markets crash, then there’s a further strenght in FDI/privatization negotiations, so very profitable equity purchases in China are enabled.
    I would recommend that you will make a great contribution by clarifying
    a) whether you support protectionism, specifically high “punitive tariffs” on imports from China that will make those imports infeasible.
    b) whether you view the current account imbalances as a long term systemic problem requiring a gradual re orientation, or whether you support Geithner’s demands based on the RMb being “overvalued”.

    If the Geithner demands are met by China, we can’t expect a recovery till the China buyout is complete, and the restrictions are lifted/ exchange rate are changed back again.

    Most importantly, your analysis of current account imbalances can be used to justify much more violent and aggressive steps against China, that wouldn’t actually follow from your work. Such as trade sanctions/forced embargo of exports, perhaps even a medium intensity war in the Seas.

    And reading this post should show you why there are opposite reactions to a lot of your analysis.

  • Posted by Invisible Hand

    WOW!! I have read this article several times, and I am amazed at the knowledge, ingenuity, and insights. (A few typos evaded your spelling checker, but you’ve probably caught them by now.)

    My only quibble is with your very last paragraph, which is surprisingly terse compared to the rest of the article. For example, “demand for dollars has rematerialized”, but isn’t this a temporary transition stage, or do you think this is an equilibrium?

  • Posted by jonathan

    I had to take a little time to read the entire paper and thought it was amazing and important. At the end where you talk about how the yuan should tend to appreciate – or we need to rewrite economics texts – my thoughts turned to a theme I see building in your work generally, that China is now in important ways as wed to the US as the US is to China, that they are now so invested in the US that they have become in a real sense our currency partner. This means they can / should for their own benefit act as a stabilizing force that can help Treasury and the Fed pull the rabbit out of the hat when the bills come due. This is such a huge topic now and this work is very illuminating.

    Perhaps if the politicians connect the dots, we’ll see more political recognition of the depth of our relationship.

    On an entirely different subject, did you ever look at the end of the Olympics as the end of a stimulus project?

  • Posted by CowardlyLion


    Pertaining to your comment “However, someday someone will have to figure out what is the difference between China buying something sensitive (a political issue) and a Chinese firm buying something equally sensitive.”

    This remains the largest impediment (aside from political gamesmanship by our Congress) to most purchases by Chinese firms. The web of formal connections between the buyer and government on either the provincial or national level makes the evaluation of whom actually controls some of these firms something in the nature of guesswork (corporate BoD or the govt?). Of course, informal connections (such as Party membership and informal banking) are even more worrisome. Greater privatization would remedy that, but until that is domestically palatable, a greater level of cooperation by the firms involved can go a long way toward relieving concerns. Since the rejection of Huawei’s involvement in the 3Com acquisition there has in fact been a great deal more cooperation by PRC buyers.

    Brad, love reading all your work, yourself and Prof Pettis make for a better window on Chinese monetary and economic policy than any official source I have found. Unfortunately, I’m not qualified to comment on much on topic;)

    I don’t see how your proposition squares with maintaining the dollar peg. Shares of China listed firms would be RMB denominated, and they would simply have to find another USD denominated asset. But then, I really don’t see any fix at this point, the US and PRC are riding the tiger of Bretton Woods II and I really can’t see any good outcome, aside from the hope that as the recession/depression progresses the Chinese current account surplus balances thru reduced trade and the increased domestic investment you describe. The November stimulus plan and the January announcement of increased healthcare spending suggest to me that the PRC govt may be of the same opinion, and are doing all they can to effect it.

  • Posted by Don

    I think Indian Investor likes to see himself in print. Why doesn’t he start his own blog, and see how many readers he can attract, rather than messing up other peoples blogs?

  • Posted by Michael

    Could someone explain to me how it is a detriment to a “proper” balance of global trade/capital flow and a self-serving currency manipulation for China to take dollars out of circulation, hold them in reserve, and buy foreign debt with them – in order to sustain their export surplus; while it is NOT a detriment to a “proper” balance of global trade/capital flow and a self-serving currency manipulation for the U.S. (supplier of the world’s reserve currency) to create giant fiscal deficits requiring everyone to buy dollar-denominated debt, and to print more and more dollars out of thin air to give to our loser banks – in order to sustain our consumption surplus?

  • Posted by Indian Investor

    @ Brad: Well apologize for insinuating and doubting your intentions. The belief here is that if you accuse somebody of some wrong-doing without knowing for sure, and if they haven’t, it’s the same thing as you doing the wrong yourself.
    But overall I’m still looking at demands to strengthen RMB/USD in terms of impact on factory closure and riots, and the help that all this gives to people who’re planning to invest in China, rather than the help it gives to people who may be planning to export to China.

  • Posted by nij

    Brad, do correct me if I’m wrong, but the source of Table 2 on pg12 of your paper should be “US treasury TIC” instead of (or as well as) “PBoC”, right? Since most of the numbers in column “Known US holdings” seems to reflect Nov TIC data.
    Another quick question, the next annual survey (for June 2008) is due out around April?

  • Posted by Rien Huizer


    Indian Investor has his own blog. This is his way of advertising it. Not very successfully apparently.

  • Posted by Ying


    It’s an exchange between real assets for treasury debt. The deal is that the real assets owned by US corporations in China be exchanged for cancellation of treasury securities from Chinese government. The US government has to compensate its corporations in the forms of US dollar injection.

    If a US multinational firms has assets abroad, it doesn’t need bailout cash injection from its government.

  • Posted by Ying

    US financial bailout is the bailout of the existing global financial system. Unfortunately, US economy is going to pay the price for it. I hope this is a warning for Chinese policy makers: never try to have the ambition to conquer the world by either economic or military forces. Develop its own internal economy and look after its people. Be self-reliant and don’t ask for help. That’s all.

  • Posted by VicktorCapitalist

    Brad: I will be very interested to know if China is taking any actions to hedge against the risk of USD devaluation (or devaluation in fiat currencies in general). I am referring to the debasing of USD against gold.

    I take the view that inflation/deflation debate will end, with gold price running sky high that sooner or later will bring up prices of other commodities (therefore, from “gold driven inflation” I advocate to commodity price driven inflation).

    In fact, the US may find no choice but to return to gold standard. However, a gold standard at “normal” gold price would be committing suicide, as the lack of loose monetary tools will definitely bring deflation and depression. Instead, by pegging USD to gold at ridiculously high price (“hyper gold standard” as I expect), the US could bring one-off hyper inflation, therefore one-off reflaiton of asset prices to solve the debt overhang problem.

    If China doesn’t position accordingly to due with the possibility of “gold driven inflation” and “hyper gold standard”, she may find her facing a fatal political stress when USD devalued overnight and China’s reserves loses a great portion of the purchasing power.

  • Posted by Rien Huizer


    What a curious comment. “this financial system” is the financial system. Could there be others? No idea what “price” the US economy would have to pay for what? What would this have to do with (military?) power. I guess, if you are afraid that military power breeds financial trouble, and you exect that china will have military power (what kind? It has lots of power to achieve domestic ends), just stay away from it. It is an expensive hobby and the soldiers can take of your ants without touching the belt. That is the way it was in the blessed days of Bismarck and that is the way it is still.

  • Posted by Dr.Dan

    Lets hazard a guess here.

    How long can the US continue to get free money via treasury auctions ?

  • Posted by DavidHK

    Brad> “And strangely enough, I am a bit less worried than before.”

    While impressed by your analysis, I also find your relaxed attitude strange.

    Sure, the alarm about China using its reserves to blackmail US is overblown. An economically weakened US is not in China’s interests, as it damages both China’s reserve values and China’s export industry.

    And, when China was the major treasury buyer, it was still possible for Beijing and Washington to work out some kind of an arrangement and to avoid the mutual financial destruction. There was a good chance that coordinated governmental actions (among US, China, Japan, etc) would work. Asian Central Banks typically held the reserves for long term purpose, mainly for rainy days and for supporting exports.

    The opaqueness of China’s holdings is also helpful in this regard. In addition to give Brad something to chew on, it also means that China could take some losses on the reserves, without causing a huge uproar.

    Now that China’s role becomes secondary, treasury market is governed by private funds seeking profits. Their horizons are very short, and their tolerances for loss are also very low. US finance is now dependent on the whims of market, rather than on the long term considerations of Asian central banks.

    To make it worse, when a rush for exit does start, none of the CBs would be able to do much, since they no longer do the major purchase. They could no longer play a stabilizing role, even if they want to do it. Awful as it is , joining the stampede is probably a better option.

    In my view, this is a scenario much more scary and plausible than the scenario of China wielding its reserves for power influence.

  • Posted by Jen H

    Brad / Arpana (a repost attempt, apologies for any duplication): Liked it a lot. Certainly no back of the envelope effort. Was speaking with one of your colleagues on the ‘what do we do about it’ question earlier this week, so some informal reactions straddling substance and tactics:

    ** Your hunch on China’s quiet, insatiable appetite for US corporate bonds, circa 2006, is one I’ve long suspected as well. My larger concern/frustration is why this wasn’t more of a story, particularly given the healthy above the fold scrutiny that befell the Blackstone deal at the time.

    ** If recessions and wars are both relative, and — if i’m reading you right– your grounds for concern over China’s long-standing and recently revitalized appetite for tbills is the destabilizing potential involved, how do you reconcile this alongside the fact that the Treasury is now a rather more equal opportunity debtor, no longer just China? Wouldn’t this greater redundancy bring more stability than the US-China MAD to which we have grown so accustomed? Broader point: the manner in which so many economists attack on imbalances as bad solely on grounds of their destabilizing potential has always struck me as a bit sterile and an avoidance of the larger geopolitical point. We in the US hold congressional hearings on China currency manipulation less because we are concerned about the stability of the global financial system and more because, in either perception or fact, its just plain not fair. Is there a broader case to be made that imbalances are bad for reasons beyond destabilizing potential? (acknowledging the question as leading and that your formal answer came back in October, just a call to link the two arguments at some point)

    ** Some discussion of the likely fate of the dollar, apart from the imbalances question would seem apt. My own view– so long as the RMB is rising in real terms, even as its appreciation against the $ slows, any SED or other US attempt to bring the Chinese to the table, regardless of the players, will be made considerably more difficult.

    On your assessment of the EM’s role in all of this:
    ** Decoupling questions are always packaged and scrutinized as inherently binary, all or none propositions. While obviously the emerging world is hurting worse than anyone could have expected, their abiding progress remains evident. Certainly compared to previous crises — and quite possibly compared to the US / UK in this crisis– the EM’s will recover more quickly than most economists expect in both absolute and relative terms. And not a minor point, if again we take recessions as a relative game

  • Posted by Cedric Regula

    DavidHK:”Now that China’s role becomes secondary, treasury market is governed by private funds seeking profits.”

    “US finance is now dependent on the whims of market”

    Me an’ Nest Eggy would like to add that we think this may be a good thing. We can’t speak for all private investors of course, but Nest Eggy doesn’t like bidding against organizations that own printing presses, or have the power to tax. We have to try and evaluate risk/return when buying fixed income assets. After all, Nest Eggy is an egg, not a goose.

    And the reason Nest Eggy has a short term horizon is because the government is pursuing policies that are deliberately inflationary, debase the currency, and are getting close to the point that trigger credit downgrades. Nest Eggy wasn’t borne yesterday, and any good egg with their yoke intact knows that going long term with a policy environment like that is more like a life or death decision rather than merely a “whim”.

    Also, Nest Eggy does not do well in stampedes. She tries to avoid these at all costs.

    That said, Nest Eggy still really doesn’t want to be a golden egg. Again, she is an egg, not a goose, and would prefer a small profit from investing in an environment that we had in the not that distant past.

    But that’s just how me an’ Nest Eggy see it.

  • Posted by bsetser

    Thanks for the comments. We do need to fix Table 2 (the estimated undercount number is a misprint, a digit wasn’t deleted) and yes, the sources are the US Treasury (TIC), the PBoC (for reserves/ other foreign assets) and the author’s own estimates.

    JenH — It was hard to get traction with any story on China’s purchases of corp bonds because most of the purchases came in the shadows so to speak. There was a rise in the TIC monthly data but those purchases disappeared in the survey. That made me a bit uncomfortable making strong predictions. Clearly tho the state banks were doing something when they bought $100b or so of foreign debt in 06 …

    I also do think the perception that China is gaining an unfair edge in the market (for goods) via its exchange rate is a key issue. My work on the geopolitical risks (or absence of said risks) is meant to complement that basic argument, which i take seriously. China’s policies have altered the distribution of employment inside the US, favoring some sectors over others. Those who work in sectors that have been hurt have a legitimate complaint … and it is clear the internal winners in the US haven’t been compensating the losers. I don’t see Mr. Swartzman, for example, writing checks to laidoff auto parts workers …

    As for the implications of a world where China’s absolute holdings of Treasuries continue to rise but China’s share of the total falls, i need to think more. Even if China isn’t accumulating, it could move the markets by selling — and the more you issue the greater your vulnerability to a big move in price. So i am not sure MAD goes away.

  • Posted by bsetser

    David HK — After China dumped its Agency portfolio (to be blunt and less than technical) this fall, I think the assumption that central banks are always stable, long-term investors can be questioned … though your broader point that in a world where not all issuance is absorbed by central banks there likely will be more day to day volatility strikes me as right.

    Viktor. China’s dollar risk is fundamentally unhedgeable. That is the risk that China’s government has to bear to sustain a global system where the US runs a large deficit. the only way china’s government can reduce its risk (other than adjusting so it no longer runs a current account surplus) is by increasing domestic Chinese demand for dollars, so China’s own citizens build up their foreign portfolio and take more dollar risk.

  • Posted by bsetser

    Michael — no one is required to buy US fiscal debt anymore than they are required to buy Icelandic or russian debt. It is sold in a market. And the argument that the US debt crowds out others issuance seems thin when it can be sold at low rates. Some debt is sold to the fed, which prints $ to buy treasuries as part of its standard monetary policy operations. But if the rest of the world doesn’t believe dollar denominated assets will hold value, they logically should stop trading their goods for US IOUs and instead demand payment in real US goods. There are critiques of US policy that make sense, but the argument that the rest of the world is somehow compelled to finance bad US policies isn’t one of them. key countries choose to peg to the dollar at rates that generally speaking implied accumulation of reserve assets and thus lending funds back to the US. Absent those policies, there would have been a different equilibrium.

  • Posted by K T Cat


    “And perhaps it is because China hasn’t been buying dollars because it likes the dollar or because it likes US policy. It has been buying dollars because it has pegged to the dollar and runs a large current account surplus. Absent sustained hot money outflows, that implies ongoing Chinese purchases of foreign – and likely US – assets.”

    Assuming this is true, if I were the Chinese I’d be getting very, very worried that the whole thing was spiralling out of control. Back when the deficit was in the $150-$250B range, China could count on having a pretty major say in the strength of the auctions. But as David HK noted, the enormous rise in the debt is giving nervous investors more power over China’s holdings. Pretty soon, their massive store of Treasuries will turn into a game of Russian Roulette where they squeeze the trigger every time a macroeconomic event occurs that might start the stampede.

    I think that’s the reason they’re moving into short term loans. Like everyone else, they want to be close to the door.

    As for Mutually Assured Economic Destruction, I would rather be in their position than ours. If a catastrophe occurs such as a US default, I’d take their tough, self-reliant population over our culture of take-without-earning any day of the week.

  • Posted by Counterpointer

    I won’t re-post. My stuff is at Calculated Risk.

    14 year China veteran.

    It’s just not looking that great right about now.


  • Posted by Simon Smelt

    Nice material, thanks.
    Two points:
    (1) Don’t forget the fate of the U.S. $ is not just a bilateral decision between the U.S. and China.
    (2) The U.S. has gained lots of low cost credit from China. Sounds good but China has gained vertical integration into high value added proceses and markets, knowledgeable capital (as against just “dumb” money), and the ability to grow its industry far more rapidly and in a more sophisticated way than it could have through serving its domestic markets. Can you spot the winner here?

  • Posted by dunnage

    I read the paper and hope you keep doing the excellent detective work.

    China’s currency, reserves: What if the dollar remains strong? And commodities return to the mean? In other words the dollar is rebounding from years of depreciation and oil, soybeans, copper are still overpriced. Oil was at $10/barrel a decade ago and I know that 2009 is not the first occurrence of Peak Oil in my lifetime.
    Really, the stuff is everywhere. And ya, there really is an ocean of natural gas beneath our feet. I also know you can make money with soybeans at $5.50/bushel rather than $15.

    Point is — China’s currency is not going to strengthen significantly. Reserves for an indefinite time. Yes, they will buy anything “explicitly” backed by U.S. — thank Paulsen and crew for defining implicit as nada. When world economies begin to stabilize Chinese investment will go more into assets: big time in US, but also anywhere with resources. Note that while we send soldiers everywhere, the Chinese send businessmen and bankers ( like commercial bankers, we have them too, but nobody has noticed ). Africa is a great example.

    So to be a player we need a new batch of connecteds to run the investment banks and the Treasury. Otherwise, China will helplessly watch us wallow. Could Geithner’s remarks on one day to China and the next to Japan told better who the new water boy is?

  • Posted by blue bird

    China knows well itself and the adversaries. As long as China’s economy will increase, they will stay in the status quo, but when the china’s economy growth will level at 3 percent increase or so, then will be the time to be worried. Unfortunately this will happen one day, and they will have nothing to lose but to win ….
    Keep well in mind that, not long ago they were communists, and still remember the saying:
    The proletarians have nothing to lose but their chains. They have a world to win. …