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 DJC.

    A trillion here, a trillion there and pretty soon you are talking about real US taxpayer dollars squandered. Does anyone remember when the cost of the bailout was supposed to be $500 billion? Then $1 trillion? Then $2 trillion, then a whopping leap to $3.6 trillion. It’s time top up the taxpayer ante once again. Fortune Magazine is reporting Bank bailout could cost $4 or maybe $5 trillion. Citigroup, Bank of America, and Wells Fargo are gigantic black holes that will suck in every taxpayer dollar available. All taxpayers will get, if anything, are a few quarks that escape.

  • Posted by Indian Investor

    Brad: So long as China is running a current account surplus it will be financed the world…
    I think this should be “financing” instead. I write a lot of wrong grammar, but I noticed you appreciate these refinements.

  • Posted by Indian Investor

    Brad: It felt like the US was living on borrowed time, with a large external deficit than clearly couldn’t be financed in the private market.

    I think the use of the double negative here is less effective than probably just saying “… a larger external deficit than could be financed in the private market…”

  • Posted by bsetser

    indian investor — thanks for the catch, it should be financing.

    DJC — posting a comment once is enough. there will be ample opportunity to debate the merits of pushing china to adjust its exchange rate in the future. This chain should be about the paper I just released.

  • Posted by Indian Investor

    Brad: I have spent a lot of trying to track China’s portfolio

    You meant .. a lot of time …

    These are minor corrections.I think that you like to make the post better with corrections.

    Thanks a lot for sharing some brilliant analysis of China’s portfolio. People always disagree about the conclusions to be drawn from analysis, even Nobel prize winners sometimes can’t agree on basic questions of policy. Though a lot of my conclusions are different from yours, that doesn’t take away from the effort and quality of your work. Also I appreciate that you are relatively open to considering a wide range of divergent views from other people on the topics of your blog posts.

  • Posted by Indian Investor

    I’ve been going on intermittently about the infrastructure sector in India. It’s nice to note that GE’s Jeff Immelt is thinking along the same lines. Basically, the trend is that I think up some really cool ideas, and Jeff Immelt thinks those same things with a time lag. In 2001, I wrote a paper titled “Privatization of Nuclear Power in India”


    The intellectuals I presented the paper to were simply shocked at the paper. The debate about the Power Sector in India in 2001 was about whether the State Government enterprises, i.e. the provincial electricity Boards, that distributed electricity should be privatized or not! So in that context some whipper-snapper writes this paper, and most of the Macroeconomists don’t even know that there is a nuclear power plant in India LOL :-)

    A few years later Jeff Immelt, on another visit to India had high profile discussions with various top Government officials and ministers about a proposal to set up nuclear power plants in India … the rest, as they say, is history…

  • Posted by Indian Investor
  • Posted by Twofish

    I think the terms economic mutually assured destruction is an apt way of thinking about the situation. Curiously, I think economic MAD limits political leverage. China can’t threaten to sell treasuries over any random political issue just like the US and the Soviet Union couldn’t threaten to nuke each other over any random political issue.

    The only situation where I think that China would use its Treasury holdings to influence US policy is over sovereignty issues like Taiwan and Tibet, and in the case of Taiwan, I do think that Chinese holdings of US Treasuries has had a big impact on Taiwan policy, even though everyone is denying the linkage.

    The other caveat in this is that all this assumes that China and the United States continued to be ruled by groups similar to the people currently in charge. If you have a massive economic downturn that lasts for years, that situation is almost certainly not going to be the case.

  • Posted by Howard Richman


    Your detective work is amazing! But your conclusion is especially prescient. I especially liked this passage:

    “The longer the United States relies on Chinese financing to avoid necessary adjustment—one where it pays for its imports with exports rather than debt—the harder the transition is likely to be….

    “Creating a more financially balanced global economy will be difficult so long as China’s
    government continues to peg tightly to the dollar and add large sums to its foreign assets….

    “Rebalancing will be complicated
    if the United States and other larger deficit countries provide more macroeconomic stimulus in the downturn than the larger surplus countries….”

    However, despite the fact that it is in the interest or the United States and the global economy for China to let the RMB appreciate, they will not do so. Why should they?

    They continue to gain market share in their competition with western industries. The United States is willing to go into ever-deeper debt in order to stimulate their economy while they expand export subsidies and build new industries to compete with American production, including an aircraft production industry. We are intent on committing economic suicide, so why should they stop us?

    Howard Richman

  • Posted by Twofish

    Richman: We are intent on committing economic suicide, so why should they stop us?

    Because we happen to live in a single interconnected global world, and it’s impossible for either the US or China to self-destruct without destroying the other’s economy.

  • Posted by Cedric Regula

    I guess China could just buy GM, merge them with the Chinese automakers that are trying to enter the US market and in one fell swoop re-take the number one global producer spot from Toyota.

    At some point the leverage gets to be enough to overcome congressional hurdles about foreign ownership of US companies.

    But the good part is that would be a way to finally re-structure GM into a real company.

  • Posted by Howard Richman


    The $1.7 trillion of Chinese savings in the United States is exempt from U.S. income taxes.

    If we changed our tax code and renegotiated our tax treaties, we could withhold about 30% income tax from the interest that the Chinese government receives.

    Let’s assume that the average interest rate that they receive this year is 3%. Then withholding 30% of that would provide the U.S. government with $15 billion additional revenue.

    Howard Richman

  • Posted by Cedric Regula


    Good idea about taxing the deadbeats. On my global bond funds I always get a line item for foreign taxes paid (which I can deduct from my taxes), so the concept is not far fetched at all and is in practice already elsewhere.

    Canada also does that with foreign investors in Canadian Royalty Trusts.

  • Posted by Jian Feng

    You suggested that the increase in private investment in US treasury (by $1.3T in 2008, mostly in Q4 perhaps) makes US less relying on China to buy treasuries. Such increase in private holding of US treasuries is likely to be more, perhaps much more, in 2009, with all the bad news. Is it reasonable to make a guess in the order of $5T or so? This treasury bubble may create a huge problem when it bursts. With the recovery of equity price in 2010 perhaps, will there be a sudden sell of privately held US treasuries? If so, would that force China to sell as well to prevent a steep loss? While it MIGHT be possible to negotiate with China politically to ask it not to sell US treasuries, it is impossible to prevent the herd of private investors from a stampede. Jim Rogers is using some very bad words on people who are buying US treasuries. In any case, other things may happen to trigger the sell. It seems that anytime when you have a sudden accumulation of money somewhere (a bubble), it will invariably burst. What is the current total amount of US treasuries? Would a few trillion dollars in or out cause significant trouble?

  • Posted by Twofish

    Richman: Let’s assume that the average interest rate that they receive this year is 3%. Then withholding 30% of that would provide the U.S. government with $15 billion additional revenue.

    a) As far as I can tell, the IRS doesn’t have legal authority to tax the Chinese government.

    b) Interest withholding generally does not happen in corporate accounts, and also it usually doesn’t happen in personal accounts.

    c) $15 billion/year is a trivially small amount of money as far as the government goes.

  • Posted by DJC.

    A foreign investment tax on long-term capital maybe politically correct but absolutely terrible economic policy to tax productive capital. Toyota and Honda will transfer US manufacturing operations to Canada if long-term foreign investment capital is heavily taxed. A better idea would be to tax short-term speculative capital employed by Wall Street Hedge Funds than contribute to the extreme volatility in the stock and foreign exchange markets.

  • Posted by Indian Investor

    Do you have any thinking on US exports to share? There is a lot of opportunity for US exports to India that I can think of, though a few details aren’t clear to me yet. This is in the context that your paper on sovereign debt and your essay today are both pointing to increased US exports as a solution. This requires both a clear understanding of the current level of exports, and new opportunities that are practical to pursue. Is there any plan from the Department of Commerce that deals with this issue, or from anyone else? I would think this is part of their regular job, so if there are opportunities to export, especially ones that are linked to RMB/USD exchange rates, that discussion must have happened somewhere in detail. If Geithner is favoring increased US exports, rather than increased flow of capital to China, there must be some statements to that effect that can be gone through.

  • Posted by Twofish

    Cedric: I guess China could just buy GM, merge them with the Chinese automakers that are trying to enter the US market and in one fell swoop re-take the number one global producer spot from Toyota.

    Won’t happen. CFIUS would use Exon-Florio to block the sale as being against the national security interests of the United States. Basically the US government can and does block any foreign investment from China that it doesn’t like.

    I suspect that as far as international capital flows, things are going to become very state directed.

    One other thing, if the US allows China to purchase something, then the China should think twice about actually going through with the deal (and vice versa). The fact that a foreign government is willing to let you buy something is a sign that you might think twice about taking it.

  • Posted by Ying

    Agree with Jian. The US Fed is trapped this time. It can’t let the interest rates go up because the burden of financing would be so huge if the rates go up. If the private money don’t go back to the original places, the economy cannot recover. I am wondering what is the exit strategy for this. Of course, there must be an exit strategy for “Asia Trap” too.

  • Posted by Cedric Regula

    indian investor:

    Bad news. India has got no credit and your money is no good. Ironically, India’s Debt to GDP ratio is 80% and the US just hit that level too. But no one ever said life was fair.


    S&P Downgrades Rating Of Indian Currency

    New York, September 19: : International credit rating agency, Standard & Poors (S&P) today downgraded India’s long-term and short-term local currency rating on the ground of poor finances of public sector and growing debt burden.

    Continued large fiscal deficit with slow pace of economic reforms would lead to a further rating downgrade, the company said in a release here.

    The long-term sovereign local rating has been lowered to”BB+” from “BBB-” and the short-term local currency sovereign credit rating to B from A-3, the release said.

    However, the company has affirmed the “BB” long-term and “B” short-term foreign currency sovereign rating for India.

    The company’s managing director, John Chambers, said that local currency downgrade reflects the government’s growing Indian rupee debt burden and its inability to stem the financial weakening of the public sector.

    The central government, a coalition of two dozen political parties, has been unable to contain its growing budget deficit, expected to touch six per cent of the GDP in the current fiscal, he added.

    As a result, he pointed out the consolidated debt of the central and state government is estimated to exceed 80 per cent of GDP this year.

    Inability of the country’s leadership to implement the announced reform policies in a timely manner contributes to India’s falling credit worthiness, Mr Chambers claimed.

    Citing an example, he said political disagreements threa-ten to set back India’s privatisation programme, which had enjoyed success in recent months.

    Mr Chambers claimed that the resulting loss in government’s credibility, along with foregone revenues from the sale of large public sector firms, weakens investor confidence and enlarges the government’s borrowing needs. (PTI)

  • Posted by MakeMeTreasurySecretary

    2fish says “I think the terms economic mutually assured destruction is an apt way of thinking about the situation.” I will have to strongly disagree with this assessment. Losing one’s technological edge and manufacturing base is a disaster. Losing (part of) 2.3 trillion paper dollars is a trifle, by comparison. There is simply no comparison.

  • Posted by Cedric Regula


    I know the US resists these things. I’m just thinking if the status quo doesn’t stay the same, since current events say it is under stress, where might either party buckle under. They may horse trade some things in arriving at a bargain.

    It is a bit of a stretch to say GM is a national security interest. That usually means things like defense, oil reserves, and leading edge technology things like satellite, launch vehicles, supercomputers, chip technology etc…

  • Posted by Glen M

    WRT your observation ;

    ” 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.”

    …. this only partially examines, who holds the power. While China may decide to liquidate its US holdings, no doubt, there will be other buyers. The other side of the equation is that the US could do more damage to China by prohibiting its imports, in compliance with WTO rules (remedies for chronic trade deficits).

    In the end the power lies in where the consumer, in this case the American consumer, spends his/her money. That is a decision that the US can and may influence more than China.

  • Posted by DJC.

    Cedric Regula: It is a bit of a stretch to say GM is a national security interest.

    DJC: The US government blocked China CNOOC from the California Unocal acquisition on National Security Threat grounds. Unocal produced only 2% of US domestic oil production. The primary energy assets of Unocal were across Southeast Asia.

  • Posted by Indian Investor

    @ Cedric Regula:
    By the way, Cedric, what you have posted is a 2002 downgrade by S & P. It isn’t a current downgrade, and right now the Govt. Debt , etc isn’t a problem in India. Everybody is waiting to buy Indian stocks.


  • Posted by Cedric Regula

    indian investor:

    I was just teasing a little.

    You are right, I know little about India. Not that I haven’t tried to find out more. During my working career first in engineering, then in computer programming, I met many Indian co-workers. I always asked them “What’s wrong with India?”. They always shook their heads, rolled their eyes, and then there was silence.

    So that’s why I don’t know much about India.

  • Posted by K T Cat

    I can’t imagine the US would tax foreign investments in Treasuries. They’re desperate for those loans.

  • Posted by DJC.

    Brad Setser’s continuing thesis that somehow China is responsible for US overspending and overindulgence really needs a reality check. Americans really need to save more and spend less. The TARP program has been an absolute disaster, a transfer of US taxpayer wealth to the management and owners of politically-connected financial institutions (ie. Citicorp and Goldman Sachs for executive bonuses). Rewarding cataclysmic failure like this has to be what led to the fall of the Roman Empire.

    The Chinese aren’t responsible for the US regulatory and financial fiasco. Get it Brad.

  • Posted by CowardlyLion

    Well, it’s worth noting that there are specific provisions within the CFIUS regs to facilitate the sale of businesses in financial distress. Functionally speaking, Treasury can waive any ownership and procedural restrictions they wish to, answerable only to political constraints (as in the expedited investment by Mitsubishi into Morgan Stanley last fall, but the 2007 Wanxiang Holdings purchase of Coupled Products Group is particularly applicable). So, the question is, would there be political constraints on a PRC acquisiiton of GM?

    I don’t see any. The oft cited CNOOC example did have legitimate concerns in that non-CONUS assets would have transferred ownership, and their future productivity could be redirected away from the US for either economic or nationalist reasons. GM is not CNOOC. It’s financial distress would obviate any prestige concerns in retaining domestic ownership and encourage the US to remove it’s ongoing operational funding from the taxpayer dole. National security implications are minimal, applicable only to component part manufacture for DOD contracts. There is considerable cross-investment between US and PRC entities in the auto component industries, and any number of component-of-component parts for defense purposes are already sourced from PRC manufacturers, regulatory constraints to the contrary be damned. Ownership transfer of ITAR products to PRC entities can be mitigated with internal company firewalls or divestiture, and has been in the past.

    Anyway, 2fish hit the nail on the head (by implication). Why the Devil would any PRC entity, private or govt want to own GM? It’s crippled by debt and overcapacity, the beneficial technology and design transfers are more cheaply obtained by the various JVs between Chinese and foreign auto manufacturers already in existance.

  • Posted by gillies

    “Losing (part of) 2.3 trillion paper dollars is a trifle, by comparison. There is simply no comparison.”

    true. that amount fell between the floorboards of the pentagon and went missing, 2000/2001, and no one got fired that i remember . . .

  • Posted by Cedric Regula

    indian investor:

    I’m sure India could spend enough on infrastructure to pull the whole world out of recession. But where the money comes from is still a problem. Foreign investment will be cut way back with financial de-leveraging and falling corporate profits. And the Indian government doesn’t have the money.

    Although we are doing our best to slowly rectify that. A few years ago IBM announced they are transferring HALF their workforce to India over the next ten yars. So if India can reverse their brain drain of the last thirty years, then there will be a much larger tax base in India, rather than having Indians on a green card pay taxes in the US. You might even get Microsoft someday. Does not bode well for the US however.

    By the way, tell the government that Cameco in Canada has lots of uranium. Russia has even more and needs the money.

    Probably should keep it quiet that Embraer in Brazil makes some very nice smaller airplanes for smaller airports.

  • Posted by Twofish

    Cedric: It is a bit of a stretch to say GM is a national security interest. That usually means things like defense, oil reserves, and leading edge technology things like satellite, launch vehicles, supercomputers, chip technology etc…

    Exon-Florio allows the President to bar any corporate purchase transaction he thinks is against the national security interest of the United States. What’s important in laws is who defines “national security interest” and in this case it’s the President.

    CowardlyLion: Functionally speaking, Treasury can waive any ownership and procedural restrictions they wish to, answerable only to political constraints.

    Sure but there is no legal requirement that they do so. So ultimately it is up to Treasury to decide what China can and cannot buy.

    CowardlyLion: So, the question is, would there be political constraints on a PRC acquisiiton of GM?

    I think the answer would be hell yes. If anyone in the United States was interested in buying GM, there would be slick commercials and full page ads explaining how have China buy GM would bring armageddon. I can think up of half a dozen national security arguments “i.e. we wouldn’t want China to get electric technology to propel their submarines.” They may be bogus, but they sound good, and I can come up with about a dozen reasons why China can’t buy GM, and people get paid lots of money to do this.

    You are assuming that these debates get solved rationally. They don’t. If people in the US are emotionally scared of China buying GM, then facts don’t matter.

    A Chinese company would have to undertake an expensive and complex PR campaign and then probably bid considerably more than any American company. The problem then is if GM is worth $X to an American buyer, then why would it be worth $X + 25% to a Chinese buyer.

    And then you come up with the really big problem which is that if no one in the US wants to buy GM, why should China? Bill Gates and the members of Sam Walton family could single handedly buy GM with their personal wealth if they wanted to.

  • Posted by Jian Feng

    Can we please keep the discussion ON TOPIC? We read Brad’s blog because we want to talk about HIS topic.

  • Posted by DJC.

    Speaking of future Chinese cars, every once in a while a technology revolutionizes an entire industry. For instance, the Digital camera dethroned Kodak and Polaroid.

    In 14 short years, a company of 20 employees has grown to 130,000 with major support from the Chinese government, and in two years they are going to bring their car to the American market. It’s sure to be a hit.

    The car is electric at a price that will cost one-third less (with a sticker price estimated to be just $21,000) than the future prices of the American and Japanese auto manufacturers’ same-class vehicles. If price wasn’t enough to take notice, the future performance of the Chinese product appears ready to out-class anything that is coming to the market.

    Right now, we are being told that when the first full-size electric car comes to market, drivers can expect 100 miles per charge at best and a full-night’s recharging process. Well, BYD has changed the outlook of what to expect. BYD Auto is introducing a full-size car that will go 246 miles per charge and have the ability to give a 50 percent recharge in 10 minutes from any common household wall socket.

  • Posted by Ying


    Focusing on export market is probably not a good choice. Look at Japan, its economy is falling off cliff now. Depositing money in foreign government is not a good idea either.

    China has enough technology to build a better life of its own. There is no need to be number one or two top competitors in the world market. The goal should be focusing on the living standards of Chinese at home. Washington is telling Chinese that they have no ability to manage the huge amount of wealth entrusted in their hands and their people will tightening up their bellies to reduce consumptions for years to come. I think we better take this advice and focus on our own.

  • Posted by Cedric Regula

    cowardlylion & 2fish

    There have been cases in the past where companies had to spin off a small division that was involved in defense work as a condition for approval of the sale.

    But I wholeheartedly agree it would be a media extravaganza by management, labor, and their congressional lackeys to convince us the end of the world is just around the corner. I’d look forward to it just for the entertainment value.

    And GM is worth something. Its just arriving at how much. The global reach in marketing is worth something to the Chinese. They want a piece of the market, if not all of it, and they can market cheap made in China cars too. Or sell more GM Aveos.

    And the Chinese have too many treasuries, which is what this blog is about, and they need to spend it on something so they don’t have to dump treasuries and re-patriate back to yaun and screw up all their pegging efforts.

    So Brad can write up these suggestions in his secret memo to Timothy Geithner and the USG can work on the China Negotiation Strategy with the help of our inputs.

  • Posted by Cedric Regula

    “Right now, we are being told that when the first full-size electric car comes to market, drivers can expect 100 miles per charge at best and a full-night’s recharging process. Well, BYD has changed the outlook of what to expect. BYD Auto is introducing a full-size car that will go 246 miles per charge and have the ability to give a 50 percent recharge in 10 minutes from any common household wall socket.”

    That would take a huge breakthru in battery technology. 100-120 range is doable with a battery pack size that lweaves a tiny bit of trunk room.

    The 10 minute recharge at 15 Amps@115V is a real howler. It can be done overnight from house wiring. The only battery that can be recharged in 10 minutes is the Altair spinal titanium design and they use a huge high amperage charging station to do it.

    But I agree what we see in all-electrics coming from Detroit suck, and I think electric cars will come from France in the end, unless China beats them to it.

    But gasoline is fighting back Detroit/Euro manufactures say direct port injection is ready for prime time. It improves efficiency by 20% and adds $1200 in cost.

  • Posted by Howard Richman


    Thank you for appreciating the benefits of taxing interest earned by foreign governments, including China. The $15 billion tax collections would just be from China. Japan has about $1 trillion in dollar reserves. And many other foreign governments have hundreds of billions of dollar reserves. As interest rates rise, as they are almost sure to do, the amount of tax collected would also rise.

    Last I looked, the US government (Fed and Treasury combined) had less than $100 million in foreign currency reserves, but that was before the Federal Reserve’s October currency swaps. Still the disparity is enormous. If foreign governments retaliate by taxing interest earned by the government’s reserves in their countries, we still gain tremendously.

    In order to tax foreign governments, however, we also have to tax foreign private savings from non-resident foreigners, otherwise China will just stop putting their reserves into Treasuries under their own name and channel them all through foreign bank eurodollar accounts. (In this piece, Brad points out that the Chinese already channel a large proportion of their reserves through London banks.)

    Howard Richman

  • Posted by bsetser

    let me second jian’s comments — the paper i just released took an enormous amount of work. it would be nice to get some real feedback.

  • Posted by Indian Investor

    As to what the US should do … it was always quite obvious. The US should have followed the McCain style for a stimulus program rather than the Obama style, whereas on most other counts Obama’s style wins hands down.
    If there had been a stimulus program that spends money on building 40 new nuclear power plants (it’s at least a 3-year construction), build re fueling stations for plug in electric cars, and bring the electric cars in as a regulatory measure for energy efficiency, the whole labor force of the united states wouldn’t have been enough.
    The local American auto firms are best advised to shift over to electric cars, though I would agree with Cedric that the technology isn’t great yet.

  • Posted by Indian Investor

    Brad: the paper i just released took an enormous amount of work. it would be nice to get some real feedback.

    Your paper implies that there should be more US exports, which is what we’re going on about; what sectors, which countries to export to.

  • Posted by MC


    I get the argument about private flows replacing FCB flows to finance the CA deficit.

    However, are you concerned at all that these hot money flows might abruptly shift direction as they have in the past and move away from currencies where the central banks have opened the supply spigots (except the BoJ…for now) and towards assets like precious metals or real estate?

    With real estate, the problem might self-correct but in this protectionist-fervor tinged times, and where politicial instability could turn out to be a significant tail risk, what if hot money flows into non-performing assets like gold? That cant be good for the world. And once the tipping point is reached (i.e. there is a inkling that the Fed might not be able to manage rates), how do these massive holders of US Debt respond?

    (And I’m not bringing up the inflation/deflation debate at all. I think you could see some of these asset prices go parabolic once there’s a small shift in these hot money flows becase the proponent of either argument will find their evidence and the trend will be self-reinforcing)

  • Posted by Howard Richman


    The location of Chinese funds tells us something about China’s plans. When they are in eurodollar accounts in London banks, as they are now, they can be frozen (as Carter did to Iranian funds).

    The fact that China has such a large proportion of her funds under her own name and in London banks indicates that her leaders do not currently plan any military action against Taiwan.


  • Posted by Ying


    The trend doesn’t look sustainable. I am just wondering if the speed of treasuries & agencies accumulation is faster than the speed of export growth. Is it possible that some money that goes into treasuries comes from hot money inflow. There was quite a humor that these hot money were hidden in Chinese depositing bank account. These hot money may be recycled back to treasuries.

  • Posted by seatrus

    But Jian Feng made a good point. We can all sleep a little better now knowing that more than 2 trillion is safely in the hands of the Chinese government, instead of the hands of the barbarian hordes called private investor, whose stampede will surely collapse the USD.

    Taiwan is likely to reunite with China in the next couple of years.

  • Posted by Don

    Good stuff, but backward looking in its relevance. Even if China continues to place the same proportion of its reserves in U.S. treasuries and equivalents, those reserves will be growing more slowly in the next few years than they have anytime in the past decade. And of course U.S. treasury supply will be growing faster than it has. Thus, the result is the same as if China proactively decided to move away from U.S. treasuries (at least in direction if not degree). And thus the U.S. will be left with the same near-term policy choice of how to balance higher costs of funds with monetizing the debt (and given the current state of our political character, I have little doubt where the balance will lie).

  • Posted by Jian Feng

    As long as China believes it is necessary to “manage” the exchange rate of RMB/USD, it has no other choice but buying more and more treasuries, unless it becomes politically untenable to do so. If China’s investment in US treasuries suddenly suffers a huge loss (which will make CIC’s loss like a drop in the ocean), there will be a lot of internal finger pointing and public pressure to stop the practice. If the average folks in China knew that each of them has $2000 deposited in the United States, they will either want to come here to cash that or get it back and make their life in China better. That’s part of the reasons why China does not brandish its huge wallet.

    However, like the Chinese proverb says, “There is no banquet that goes on forever”. Both China and US should see the end of the Treasury Bubble coming before it is too late for the happy marriage of the two countries. There is now a third guy sleeping between the two on the same bed. His name is the Capitalists, as in Professor Raghuram Ranjan’s book “Saving Capitalism from the Capitalists”. This third guy has no strategic interests with anyone, has no Taiwan issue or Democracy problem. He will leave for a greener partner as soon as he can. What would the US do? It almost certainly will do nothing, just like a liquor store will not stop selling booze to drunkards. The ball is in China’s hand. To rely on a stranger’s “full faith and credit” to grow your own money is not too much better than to live on a stranger’s charity.

    When Premier Wen Jiaobao was saying at Davos that China needs to learn banking from the West, he was neither being humble nor being polite. There is a lot to learn from the West on money management at a global scale. But that is not enough. China has to invent its own gig to use its money, not to grow the money as a virtual number on some computer in Washington. A fiat is only as good as the credit of the issuer. When you own 20% of the bank (China’s foreign reserve is 20% of US national debt), you got to be very careful what the bank is printing.

    The only viable way for China is to spend the money on Keynesian economics to make the country stronger. The Communist rulers should really think about the lyrics when they sing the song every time at the completion of the Party’s plenary meetings –

    “There are no supreme saviours
    Neither God, nor Caeser, nor tribune.
    Producers, let us save ourselves”

    – The Internationale

  • Posted by bsetser

    if anyone has had trouble downloading the .pdf of the paper via the links in the post, please let me know …

  • Posted by Indian Investor

    The link wasn’t working yesterday but it’s working now. People like me who’re not professional economists aren’t capable of giving any really useful feedback on issues like how these models work, and so on.
    The Russia-Ukraine Petroleum Gas dispute has been resolved on January 20, 2009. I just discovered this today!
    This is the kind of thing that makes people lose tons of money, rather than not understanding complicated models. I’m fortunate not to have made any incorrect decisions in the interim.

  • 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. …